**Back
          to Table of Contents**
 **Index
          to Financial Statements**





**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**WASHINGTON,
      D.C. 20549**








**FORM
      10-KSB**





(Mark
      One)


x
            ANNUAL
                REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
                1934





For
      the
      fiscal year ended: DECEMBER 31, 2005





o
            TRANSITION
                REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
                1934





For
      the
      transition period from ______________ to ______________





Commission
      File Number: 0-13092





**SPECTRASCIENCE,
      INC.**


(Development
      Stage Enterprise)





(Name
      of
      small business issuer in its charter)





MINNESOTA
            41-1448837(State
                of incorporation)
            (I.R.S.
                Employer Identification No.)





11568-11
                Sorrento Valley Road, San Diego, CA
            92121(Address
                of principal executive offices)
            (Zip
                Code)





Issuer’s
      telephone number: (858) 847-0200





Securities
      registered under Section 12(b) of the Exchange Act: NONE





Securities
      registered under Section 12(g) of the Exchange Act:


COMMON
      STOCK, $0.01 PAR VALUE


(Title
      of
      Class)





Check
      if
      the issuer is not required to file reports pursuant to Section 13 or 15(d)
      of
      the Exchange Act. o




Check
      whether the issuer (1) filed all reports required to be filed by Section 13
      or
      15(d) of the Exchange Act during the past 12 months (or for such shorter period
      that the registrant was required to file such reports), and (2) has been subject
      to such filing requirements for the past 90 days. YES x NO
o








Check
      if
      there is no disclosure of delinquent filers in response to Item 405 of
      Regulation S-B contained in this form, and no disclosure will be contained,
      to
      the best of registrant’s knowledge, in definitive proxy or information
      statements incorporated by reference in Part III of this Form 10-KSB or any
      amendment to this Form 10-KSB. x




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act). Yes o No
x





Issuer’s
      revenues for each of its fiscal years ended December 31, 2005 and 2004 were:
      $0





As
      of
      March 22, 2006, the number of outstanding shares of the Registrant’s Common
      Stock, par value $0.01 per share, was 37,572,262. The aggregate market value
      of
      the voting stock held by non-affiliates of the registrant was approximately
      $37,336,344 based on the last reported sale price of $1.55 on March 22, 2006.
      (Symbol SCIE.OB)





**ISSUERS
      INVOLVED IN BANKRUPTCY**


**PROCEEDINGS
      DURING THE PAST FIVE YEARS**





Check
      whether the issuer has filed all documentation and reports required to be filed
      by Sections 12, 13 or 15(d) of the Exchange Act after the distribution of
      securities under a plan confirmed by a court. Yes x No
o





**DOCUMENTS
      INCORPORATED BY REFERENCE**





**None**





Transitional
      Small Business Disclosure Format (Check one): Yes o     No x







**Back
          to Table of Contents**
 **Index
          to Financial
          Statements**


**SPECTRASCIENCE,
      INC.**


(Development
      Stage Enterprise)





**FORM
      10-KSB**


**For
      the Fiscal Year Ended December 31, 2005**





TABLE
      OF CONTENTS


PageBACKGROUND
            3PART
                I
            4Item
                1. Description of Business
            4Item
                2. Description of Property
            19Item
                3. Legal Proceedings
            20Item
                4. Submission of Matters to a Vote of Security
                Holders
            21PART
                II
            21Item
                5. Market for Common Equity, Related Stockholder
                Matters, and Small Business Issuer Purchases of Equity
                Securities
            21Item
                6. Management’s Discussion and Analysis or Plan of
                Operation
            24Item
                7. Financial Statements
            42Item
                8. Changes in and Disagreements with Accountants on
                Accounting and Financial Disclosure
            61Item
                8A. Controls and Procedures
            61Item
                8B. Other Information
            62PART
                III
            62Item
                9. Directors and Executive Officers. Promoters and
                Control Persons, Compliance with Section 16(a) of the Exchange
                Act
            62Item
                10. Executive Compensation
            64Item
                11. Security Ownership of Certain Beneficial Owners
                and Management and Related Stockholder Matters
            65Item
                12. Certain Relationships and Related
                Transactions
            68Item
                13. Exhibits
            69Item
                14. Principal Accountant Fees and
                Services
            69SIGNATURES
            70




-2-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**


FORWARD-LOOKING
      STATEMENTS





Certain
      statements in this Annual Report on Form 10-KSB constitute “forward-looking
      statements” within the meaning of Section 27A of the Securities Act of 1933, as
      amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
      When used in this Report, or in our future filings with the SEC, in our press
      releases and in oral statements made with the approval of an authorized
      executive officer, the words or phrases “anticipates,” “estimates,” “expects,”
“will likely result,” “projects,” “believes,” “intends,” or similar expressions
      are intended to identify such forward-looking statements, but are not the
      exclusive means of identifying such statements. These forward-looking statements
      involve risks and uncertainties that may cause our actual results to differ
      materially from the results discussed in the forward-looking
      statements.





We
      caution you not to place undue reliance on these forward-looking statements,
      which speak only as of the date made. We undertake no obligation to revise
      any
      forward-looking statements in order to reflect events or circumstances after
      the
      date of such statements. Readers are urged to carefully review and consider
      the
      various disclosures made by us in this report and other reports we file with
      the
      SEC that attempt to advise interested parties of the risks and factors that
      may
      affect our business.





BACKGROUND





SpectraScience,
      Inc. (the “Company”) filed for bankruptcy protection on September 13, 2002 (US
      Bankruptcy Court, District of Minnesota, Case No. 02-42904). The case was
      converted from a liquidation under Chapter 7 to a Chapter 11 reorganization
      in
      early 2003. The Company’s Plan of Reorganization (the “Plan” or the “Plan of
      Reorganization”) was confirmed on July 22, 2004 and became effective on August
      23, 2004. However, the Company received funding and commenced operations
      effective August 2, 2004. As of August 2, 2004 (for purposes of this Report,
      the
“Effective Date”) the Company became the “Successor Company.” The Company as it
      existed prior to August 2, 2004 is referred to as the “Predecessor Company.”
During the bankruptcy the Company was under the control of a court appointed
      trustee and had no management (all officers and directors resigned), no legal
      counsel, no independent auditors, no transfer agent, and no operations.





The
      Predecessor Company last filed a report on Form 10-KSB for the fiscal year
      ended
      December 31, 2001 (filed March 29, 2002). It filed reports on Form 10-QSB for
      the first two quarters of 2002. It did not file reports on Form 10-KSB for
      the
      fiscal years ended December 31, 2002 and 2003. It did not file any quarterly
      or
      other reports in 2003 or 2004, except for a report on Form 8-K filed on February
      7, 2003 concerning conversion of its bankruptcy case from Chapter 7
      (liquidation) to Chapter 11 (reorganization) and a report on Form 8-K filed
      on
      August 6, 2004 concerning confirmation of the Plan and related matters. The
      Successor Company filed a report on Form 10-KSB for the fiscal years ending
      December 31, 2004, 2003 and 2002 (filed July 5, 2005) and has filed reports
      on
      Form 10-QSB for the first three quarters of 2005.





The
      Company has adopted “fresh-start reporting” effective August 2, 2004, given the
      absence of any operating activity or other significant activity for almost
      two
      years, in accordance with the guidelines of the A.I.C.P.A.’s Statement of
      Position 90-7, “Financial Reporting by Entities in Reorganization Under the
      Bankruptcy Code” (“SOP 90-7”).




-3-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





This
      report on Form 10-KSB covers the fiscal years ended December 31, 2005 and 2004,
      including financial statements and notes thereto for each year. This report
      also
      includes a statement of operations, stockholder’s equity and cash flows for the
      years ended December 31, 2005 (Successor), the seven months ended August 1,
      2004
      (Predecessor) and for the five months from August 2, 2004 (first day of the
      Successor Company) to December 31, 2004. In addition, this report includes
      financial data from the inception date (August 2, 2004) to December 31,
      2005.





**PART
      I**





ITEM
      1. DESCRIPTION OF BUSINESS.





General


Our
      principal executive offices are located at 11568 Sorrento Valley Rd., Suite
      11,
      San Diego, CA 92121. You can reach us by telephone at (858) 847-0200; by fax
      at
      (858) 847-0880; or by email at info@spectrascience.com. We have a web-site
      at
      http://www.spectrascience.com. The information contained on our web site is
      not
      deemed to be a part of this document.





Development
      of the Business


SpectraScience,
      Inc. (“SpectraScience” or the “Company”) was incorporated in the State of
      Minnesota on May 4, 1983 as GV Medical, Inc. In October 1992, GV Medical
      discontinued its prior business, refocused its development efforts and changed
      its name to SpectraScience, Inc. From 1996 until filing for bankruptcy in 2002,
      the Company primarily focused on developing the WavSTAT(TM) Optical Biopsy
      System (“WavSTAT(TM) System”). The WavSTAT(TM) System is a proprietary,
      minimally invasive technology that optically scans tissue in real-time to
      distinguish between normal and pre-cancerous or cancerous tissue, without the
      need to remove tissue from the body.





Reorganization


On
      September 13, 2002, the Company voluntarily filed for bankruptcy protection
      under Chapter 7 of the Bankruptcy Code. After negotiations between the Trustee,
      the Creditor Committee, and a potential investor, it was agreed that the case
      should be converted to a Chapter 11 reorganization. On February 5, 2003, the
      Court signed an order converting the case to a Chapter 11 case. Negotiations
      with the potential investor discontinued and a new investor proposed a Plan
      dated May 12, 2004. The bankruptcy court gave final approval to the Plan on
      July
      22, 2004, and the Plan became effective on August 23, 2004. The Company received
      funding and commenced operations effective August 2, 2004. As of August 2,
      2004
      (for purposes of this Report, the “Effective Date”) the Company became the
“Successor Company.” The Company as it existed prior to August 2, 2004, is
      referred to as the “Predecessor Company.”





Under
      the
      Plan, the Company:





§
            settled
                and canceled notes, warrants and monetary claims on August 23, 2004
                of
                $952,570 ($331,270 from the former CEO, $535,000 from note and warrant
                holders and $86,300 in accrued interest) by the issuance of 6,250,020
                shares of common stock.






-4-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**




§
            issued
                11,076,447 shares of common stock to stockholders who participated
                in an
                offering of three new shares of common stock in exchange for cancellation
                of one outstanding share and $0.24 cash generating cash proceeds
                of
                $886,116.





§
            issued
                12,384,298 shares to Spectra Acquisition LLC (“SA LLC”), the sponsor of
                the Plan, in satisfaction of a $50,000 investment and as an incentive
                to
                carrying out the Plan.





§
            settled
                claims to vendors of $66,222 through the payment of cash in the amount
                of
                $5,885. The remaining amount of $60,337 was written
                off.





§
            settled
                claims to employees in the amount of $34,762 through the payment
                of cash
                of $6,273. The remaining amount of $28,489 was written
                off.





§
            wrote
                off liabilities in the amount of $108,699 for accrued liabilities
                and
                trade notes payable that was not to be paid as part of the
                Plan.





§
            on
                the Effective Date, the Company established a new Board of Directors
                consisting of Jim Hitchin, Mark D. McWilliams, Rand Mulford and Chester
                Sievert. Mr. Hitchin was elected President, Chief Executive Officer,
                Secretary and Chief Financial Officer. Under the Plan the Board of
                Directors shall remain in place for three years after the Effective
                Date,
                at which time the bylaws then in effect shall determine
                elections.





Products
      and Markets





Our
      first
      product, which has been approved for marketing by the US Food and Drug
      Administration (the “FDA”), is used during endoscopy of the colon when screening
      for colon cancer. We are currently in a Phase II clinical trial of a product
      using the same technology for detecting esophageal cancer. We believe that
      our
      core technology is a platform that can be developed for use in many areas of
      the
      human body to detect pre-cancer and cancer.





Industry
      Overview





COLORECTAL
      CANCER





The
      American Cancer Society reports colorectal cancer as the third most common
      cancer diagnosed in the United States ("US") with approximately 145,290 new
      cases of colorectal cancer diagnosed in 2005. With an estimated 56,290 deaths
      in
      2005, colorectal cancer is the third leading cause of cancer death in the USA.
      Colorectal cancer affects both men and women, but the incidence is 35% higher
      in
      men according to the American Cancer Society. Candidates for colorectal cancer
      screening include all persons, with or without symptoms, over the age of 50
      (or
      an estimated 100 million people in the US) and will increase 20% over the next
      ten years. Colorectal cancer statistics for the European Union are
      similar.




-5-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





Colorectal
      cancer is primarily diagnosed through the discovery and histo-pathologic
      analysis of polyps. Colon polyps are small masses of tissue found in the lining
      of the colon that may be either benign or malignant. The most commonly performed
      and generally accepted colorectal cancer screening procedure to detect polyps
      is
      an endoscopy of the lower colon also known as a flexible sigmoidoscopy or a
      full
      colonoscopy. According to the American Society for Gastrointestinal Endoscopy
      guidelines for colorectal cancer screening, large polyps (greater than 1
      centimeter) are generally removed and sent to pathology for evaluation. On
      the
      other hand, the guidelines further state that small polyps (less than 1
      centimeter which account for approximately 85% of all “polyps”) require
      "individualized treatment on a case by case basis". The clinical utility of
      the
      WavSTATTM System occurs when the physician must decide the best course of
      treatment for small polyps. When small polyps are found, it is left to the
      physician's discretion, based on a visual assessment and other factors, whether
      to remove the polyp, place the patient under surveillance, or to biopsy. If
      a
      biopsy is performed and cancer or pre-cancer is documented by pathology, the
      entire polyp must then be removed during a second endoscopy procedure.





Using
      current procedures and techniques to detect and treat colorectal cancer,
      five-year survival rates as reported by the American Cancer Society are as
      follows:





§
            90%
                of patients live five years or longer, if the cancer is detected
                and
                treated at an early stage;




§
            only
                67% of patients live five years or longer, if the cancer spreads
                outside
                the polyp and colon to nearby organs or lymph nodes;
                and





§
            the
                five-year survival rate for those patients in whom the cancer has
                spread
                further to the liver or other organs drops dramatically to
                10%.





These
      statistics indicate that early detection is essential to long-term survival.
      Unfortunately, the American Cancer Society reports that only 39% of colorectal
      cancers are currently found at an early stage. Clinical studies indicate that
      colorectal cancer screening procedures result in earlier detection and can
      prevent as many as 20% to 40% of potential colorectal cancers and subsequently
      reduce colorectal cancer deaths by 30% to 50%. Colorectal screening procedures
      not only save lives, they also save money. If a patient is not diagnosed until
      symptoms develop and the disease has spread, or if misdiagnosed at an early
      stage, the chance of patient survival plummets and more advanced treatment
      regimens such as surgery, chemotherapy and/or radiation are necessary to treat
      the patient.





The
      WavSTATTM System was specifically designed to be used during screening endoscopy
      of the colon to aid and improve the physician's ability to identify small polyps
      as normal, pre-cancerous or cancerous tissue in real time. Results from the
      Company's FDA regulated clinical studies performed at the Mayo Clinic
      (Rochester, MN), Massachusetts General Hospital (Boston, MA), Hennepin County
      Medical Center (Minneapolis, MN) and Minnesota Gastroenterology P.A. (St. Paul
      and Minneapolis, MN) demonstrated that using the WavSTATTM System during
      colorectal endoscopic screening increased the physician's diagnostic accuracy
      to
      detect pre-cancerous or cancerous polyps from 82.7% to 96.3%, a very significant
      statistical increase.




-6-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





Based
      on
      the results demonstrated by these clinical studies, management believes that
      using the WavSTATTM System will:





§
            Significantly
                improve the physician's diagnostic accuracy to determine whether
                small
                polyps in the colon are pre-cancerous or
                cancerous;





§
            Improve
                patient survival rates by earlier detection and treatment of cancers,
                and
                more importantly pre-cancers, by more accurately identifying cancers
                or
                pre-cancers the physician may
                misdiagnose;





§
            Improve
                the patient's quality of life by providing an immediate analysis
                of the
                tissue, thereby eliminating the anxiety of waiting several days to
                hear
                the pathology results;





§
            Enable
                the physician to diagnose and treat the patient during the same endoscopy
                procedure with the same biopsy instrument, thereby potentially reducing
                the need for scheduling a second expensive endoscopy for treatment
                purposes;





§
            Be
                cost effective by significantly reducing the number of physical biopsies
                performed and by reducing the need for an unnecessary second endoscopy;
                and





§
            Be
                cost effective by reducing the number of misdiagnosed patients, thereby
                potentially eliminating the need for more costly advanced treatments
                such
                as surgery, chemotherapy and/or
                radiation.





ESOPHAGEAL
      CANCER





The
      Company plans to complete a second application with the FDA for the WavSTATTM
System for the detection of pre-cancerous and cancerous tissue in the esophagus.
      The incidence of esophageal cancer in the U.S. is growing at a rate which is
      five times faster than any other type of cancer.





The
      progression toward esophageal cancer begins with several pre-cancerous stages.
      It is critical for the physician to be able to identify these various stages
      of
      the disease in order to deliver the most appropriate treatment. As with
      colorectal cancer, early and accurate detection of esophageal cancer results
      in
      less invasive, more cost effective treatments with a greater chance for long
      term patient survival.





Barrett’s
      esophagus is a condition of the lining of the lower esophagus thought to be
      caused primarily by Gastro Esophageal Reflux Disease (“GERD”), more commonly
      known as chronic heartburn. Barrett’s esophagus is considered to be a
      pre-malignant stage and a precursor to esophageal cancer. Physicians typically
      recommend that persons with chronic heartburn should have an endoscopy to look
      for Barrett’s esophagus. Some Barrett’s patients will advance further to a stage
      where additional abnormal tissue called dysplasia is present. Dysplasia is
      known
      to be the next progressive step toward esophageal cancer and is categorized
      in
      stages of low grade and high grade. Barrett’s esophagus, dysplasia and
      esophageal cancer patients are currently diagnosed by an endoscopy of the
      esophagus with multiple physical biopsies of the inner lining.




-7-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





High-grade
      dysplasia is a very critical stage to correctly diagnose because physicians
      frequently recommend surgical resection or removal of the esophagus if Barrett's
      esophagus with high-grade dysplasia is diagnosed. Unfortunately for the patient,
      dysplasia is difficult to find and/or diagnose because it is not reliably
      visible to the physician during standard endoscopy. Diagnosis is critical,
      therefore biopsies (as many as 20 at once) are performed either randomly or
      in a
      geometric pattern throughout the length of the esophagus in the hope of finding
      the most appropriate tissue to biopsy.





Current
      medical practice typically follows the guidelines described below:





§
            Patients
                with chronic GERD receive a screening endoscopy of the esophagus
                with
                multiple biopsies to check for Barrett's
                esophagus;





§
            Patients
                with Barrett's esophagus receive an endoscopy with multiple biopsies
                every
                two years to check for dysplasia;





§
            Patients
                with Barrett's esophagus that has progressed to include low grade
                dysplasia receive an endoscopy with multiple biopsies every 6 months
                to
                check for high grade dysplasia; and





§
            Patients
                with Barrett's esophagus that has progressed to include high grade
                dysplasia receive an endoscopy with multiple biopsies every 3 months
                to
                check for cancer and/or may be referred for esophageal surgical resection,
                photodynamic therapy or electrical
                ablation.





The
      Esophageal Cancer Education Foundation estimates that 14,200 new cases of
      esophageal cancer were diagnosed in the year 2004, with a greater than 90%
      mortality rate. The relatively high death rate associated with esophageal cancer
      typically results from a lack of diagnosis until the cancer has grown to an
      advanced stage. As previously described, the frequency of endoscopic
      surveillance for these patients increases as the pre-cancerous stages advance
      in
      hopes of providing the earliest possible diagnosis.





SpectraScience
      completed a Phase I clinical study in April 2002 using its WavSTATTM System for
      the detection of pre-cancerous and cancerous tissue in the esophagus. This
      clinical trial was designed to determine the viability of using our
      spectroscopic techniques to detect esophageal cancer in Barrett's patients,
      and
      to develop and demonstrate the feasibility of the WavSTATTM System for this type
      of application. A total of 87 patients with Barrett's esophagus were enrolled
      into the trial with 326 optical and physical biopsies taken. The results of
      our
      preliminary evaluation show that we were able to obtain a sensitivity of 95%
      and
      a specificity of 80% in determining high grade versus low grade dysplasia or
      non-dysplastic Barrett's esophagus. These results suggest that use of the
      WavSTATTM System is feasible in detecting Barrett's esophagus at its various
      stages. We plan to add additional patients to this study to provide sufficient
      information for an application to the FDA with a PMA supplement. The Phase
      II
      clinical study is in process and is expected to be completed in
      2006.




-8-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





WavSTAT(TM)
      Optical Biopsy System





The
      WavSTAT(TM) Optical Biopsy System allows the endoscopist to distinguish in
      real
      time whether tissue is normal, as opposed to pre-cancerous or cancerous, by
      optically scanning tissue with an optical fiber and obtaining an instant
      analysis. Management believes use of the WavSTAT(TM) System can significantly
      improve the endoscopist’s diagnostic accuracy, enabling the endoscopist to
      immediately determine the best course of treatment for the patient, reducing
      the
      need for additional procedures, minimizing the number of biopsies taken and,
      in
      some cases, permitting the physician to combine a diagnostic and therapeutic
      procedure in one visit.





Currently
      the WavSTAT(TM) System has approval to be marketed with a software application
      for adjunctive use by the physician to distinguish in real time whether colon
      tissue is normal, as opposed to pre-cancerous or cancerous. The Company has
      also
      developed additional statistical algorithm software that can be used with the
      same WavSTAT(TM) System to differentiate between normal esophageal tissue or
      Barrett’s esophagus and dysplastic or cancerous tissue.





The
      WavSTAT(TM) System has three components:





§
            a
                console which houses a laser, electronic components that collect
                emitted
                fluorescent signals, and a computer that operates the WavSTAT(TM)
                System,





§
            WavSTAT(TM)
                Optical Biopsy Forceps which incorporate an optical fiber that transmits
                and collects light energy to and from the tissue being evaluated;
                the
                WavSTAT(TM) Optical Biopsy Forceps can also be used to treat the
                patient
                by removing diseased tissue after diagnosis has been made,
                and





§
            proprietary
                software that manages system operations and a statistical tissue
                recognition algorithm that facilitates data analysis and provides
                an
                interpretation of the tissue.





The
      WavSTAT(TM) System operates by transmitting low level monochromatic laser light
      from the console through the optical fiber in the forceps directly to the tissue
      being analyzed. The tissue in contact with the optical fiber absorbs the light,
      and the resulting tissue auto-fluorescence is collected and returned to the
      console for analysis by the same optical fiber. The result of the analysis
      is
      then immediately displayed on the monitor for the endoscopist’s use in making a
      clinical decision.





We
      believe that our core technology can be applied to other medical specialties
      to
      differentiate between normal, and pre cancerous or cancerous tissues in other
      areas of the body. We can provide no assurance that the WavStat(TM) System
      will
      be commercialized, that we will capture the market share we anticipate, or
      that
      we will successfully adapt the WavSTAT(TM) System for use in other medical
      specialties.




-9-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





Product
      Research and Development





We
      intend
      to invest in research and development in 2006. However, for the foreseeable
      future, research and development activities may be performed by outside
      consultants.





Our
      near
      term research and development efforts will focus primarily on refining our
      algorithm for a Barrett’s esophagus application.





There
      can
      be no assurance that we will be able to develop other applications for the
      WavSTAT(TM) System.





Government
      Regulation





*United
      States*





Extensive
      government regulation, both in the United States and internationally, controls
      the design, manufacture, labeling, distribution and marketing of our products,
      particularly regarding product safety and effectiveness. In the United States,
      medical devices are subject to review and clearance by the FDA. The FDA
      regulates the clinical testing, manufacture, labeling, distribution and
      promotion of medical devices. If we fail to comply with applicable requirements
      we could face:





§
            fines,
                injunctions or civil penalties


§
            recall
                or seizure of our products


§
            criminal
                prosecution


§
            a
                recommendation that we not be allowed to contract with the
                government


§
            total
                or partial suspension of production


§
            inability
                to obtain pre-market clearance/approval for our
                devices


§
            withdrawal
                of marketing approvals





The
      Food,
      Drug, and Cosmetic Act, the Public Health Service Act, and Safe Medical Devices
      Act of 1990 and other federal statutes and regulations also govern or influence
      the testing, manufacture, safety, labeling, storage, recordkeeping, clearance,
      advertising and promotion of such products.





In
      the
      United States, medical devices are assigned to one of three classes depending
      on
      the controls the FDA deems necessary to ensure the safety and effectiveness
      of
      the device. The WavSTAT(TM) System is a Class III device. In addition to
      adhering to general controls to which all medical devices are subject, and
      special controls such as performance standards, post-market surveillance and
      patient registries, a Class III device must receive pre-marketing approval
      to
      ensure its safety and effectiveness prior to commercialization.





FDA
      approval to distribute a new device can be obtained in one of two ways. If
      a new
      or significantly modified device is “substantially equivalent” to an existing
      legally marketed device, the new device can be commercially introduced after
      filing a 510(k) pre-market notification with the FDA and the subsequent issuance
      by the FDA of an order permitting commercial distribution. Changes to existing
      devices that do not significantly affect safety or effectiveness may be made
      without an additional 510(k) notification. We received 510(k) clearance from
      the
      FDA for our disposable and reusable Optical Biopsy Forceps in December
      1996.




-10-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





A
      second,
      more comprehensive approval process applies to a Class III device that is not
      substantially equivalent to an existing product. First, the applicant must
      conduct clinical trials in compliance with testing protocols approved by the
      Institutional Review Board at each participating research institution. These
      boards oversee and approve all clinical studies at their institutions. Second,
      a
      Pre-Market Approval (PMA) application must be submitted to the FDA describing
      (i) the clinical trial results, (ii) the device and its components, (iii) the
      methods, facilities and controls used for manufacture of the device, (iv)
      proposed labeling and advertising literature, and (v) the demonstration that
      the
      product is safe and effective.





If
      the
      FDA determines, upon receipt of the PMA application, that the application is
      sufficiently complete to permit a substantive review, they will accept the
      application for filing. Review of a pre-market approval application typically
      takes from six months to two years from the date the application is accepted
      for
      filing, but can be significantly longer. Often, during the review period, a
      panel primarily composed of clinicians and acting as an advisory committee,
      will
      likely be convened to review, evaluate, and provide non-binding recommendations
      to the FDA as to whether the device should be approved. Toward the end of the
      application review process, the FDA generally will conduct an inspection of
      the
      manufacturer’s facilities to ensure that the facilities are compliant with the
      applicable Quality System Regulations requirements.





If
      FDA
      evaluations of both the PMA application and the manufacturing facilities are
      favorable, the FDA will issue either an approval letter or a conditional
      approval letter which contains a number of conditions that must be satisfied
      in
      order to secure final approval of the PMA application. When and if those
      conditions are fulfilled to the satisfaction of the FDA, they will issue a
      pre-market approval letter, authorizing commercial marketing of the device
      for
      certain indications. If the FDA’s evaluation of the PMA application or
      manufacturing facilities is not favorable, the FDA will deny approval of the
      application or issue a “not approvable letter.” The FDA may also determine that
      additional clinical trials are necessary, in which case pre-market approval
      could be delayed for several years while additional clinical trials are
      conducted and submitted in an amendment to the PMA application. The pre-market
      approval process can be expensive, uncertain and lengthy, and a number of
      devices for which FDA approval has been sought have never been approved for
      marketing.





Any
      products manufactured or distributed pursuant to FDA clearances or approvals,
      are subject to pervasive and continuing regulation by the FDA, including
      record-keeping requirements and reporting of adverse experiences when using
      the
      product. Device manufacturers are required to register their establishments
      and
      list their devices with the FDA and certain state agencies, and are subject
      to
      periodic inspections by the FDA and certain state agencies. The Food Drug and
      Cosmetic Act requires devices to be manufactured in accordance with Quality
      System Requirements regulations, which impose procedural and documentation
      requirements upon a manufacturer and any of its contract manufacturers with
      respect to manufacturing and quality assurance activities. Quality System
      Requirements regulations also require design controls and maintenance of service
      records. Changes in existing requirements or adoption or new requirements or
      policies could adversely affect our ability to comply with regulatory
      requirements. Failure to comply with regulatory requirements could have a
      material adverse effect on our business, financial condition or results of
      operations.




-11-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





The
      Predecessor Company submitted a pre-market approval application for market
      clearance of the WavSTAT(TM) Optical Biopsy System for use during endoscopic
      screening of the colon in September 1998, and it was approved by the FDA in
      November 2000. Based upon beta site outcome clinical studies, features were
      added to the WavSTAT(TM) System, and submitted as a supplement to the original
      filing in September 2001. The supplement for the WavSTAT(TM) II System was
      approved by the FDA in November 2001. We submitted a supplement for approval
      of
      WavSTAT(TM) III in February 2002 and approval was received in August 2002.
      We
      anticipate that product improvements requiring approval or any new applications,
      such as for Barrett’s esophagus, developed for the WavSTAT(TM) System will be
      submitted as supplements to the original filing rather than as original PMA
      filings.





We
      are
      also subject to numerous federal, state and local laws relating to such matters
      as safe working conditions, manufacturing practices, environmental protection,
      fire hazard control and disposal of hazardous or potentially hazardous
      substances. We will be subject to additional federal, state and local
      environmental laws when commercial development and production of the WavSTAT(TM)
      System begins. We are not aware of any manufacturing methods for the WavSTAT(TM)
      System that will require extensive or costly compliance with environmental
      regulations. However, since laws change over time there can be no assurance
      that
      (i) we will not be required to incur significant costs to comply with all
      applicable laws and regulations in the future, or (ii) the impact of changes
      in
      those laws or regulations or adoption of new laws and regulations will not
      have
      a material adverse effect upon our ability to do business.





*European
      Union and Other Countries*





The
      European Union encompasses most of the major countries in Europe, including
      our
      principal anticipated international markets. The European Union has adopted
      numerous directives and standards regulating the design, manufacture, clinical
      trial, labeling, and adverse event reporting for medical devices. The principal
      directive prescribing the laws and regulations pertaining to medical devices
      in
      the European Union is the Medical Devices Directive, 93/42/EEC.





Devices
      that comply with the requirements of the Medical Devices Directive will be
      entitled to bear the CE mark, indicating that the device complies with the
      essential requirements of the applicable directive. In order to sell a medical
      device in the European Union, the product must have the CE mark. Generally,
      companies must also go through the ISO certification process in order to obtain
      the CE mark. SpectraScience received ISO 9001 certification in July 2000, and
      CE
      mark authorization for our products in October 2000. In order to maintain ISO
      9001 certification SpectraScience must undergo a yearly audit to assure the
      European Union regulatory agencies of our compliance with ISO 9001 standards.
      Our last audit was in 2001 and we will therefore have to be re-audited to remain
      ISO 9001 certified. There can be no assurance that we will be able to maintain
      ISO 9001 certification or CE mark authorization for any of our products or
      product components. Furthermore, even though a device bears the CE Mark,
      practical complications may arise with respect to market introduction because
      of
      differences among countries in areas such as labeling requirements. We may
      be
      required to spend significant amounts of capital in order to comply with the
      various regulatory requirements of foreign countries.




-12-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





Other
      areas of the world such as Japan, Asia and South America may be targeted for
      regulatory compliance once European and Domestic sales begin.





Distribution,
      Marketing and Customers





Our
      primary objective is to become a leader in the development and commercialization
      of advanced proprietary diagnostic products with the capability to differentiate
      in real time between healthy, and pre-cancerous or cancerous tissue. During
      2006, our marketing efforts will be focused on establishing the
      cost-effectiveness of the WavSTAT(TM) System and its optical biopsy
      technology.





Demonstrating
      cost-effectiveness to integrated healthcare networks is critical to success
      in
      selling a new product. Cost-effectiveness is demonstrated through outcome-based
      clinical studies, which are essential to initiate the sales cycle. We believe
      that outcome-based trials that demonstrate better clinical outcomes and the
      acceptance of the WavSTAT(TM) System by key opinion leaders in the health care
      industry are critical elements in gaining market acceptance by integrated
      healthcare networks and third party reimbursement for the WavSTAT(TM) System.





Product
      introduction will require a sales force or a strategic corporate partner that
      has strongly established call patterns within Managed Care (examples of Managed
      Care Organizations are HMOs and PPOs. Kaiser Permanente is an example in the
      Western United States). We believe the availability of clinical support
      specialists to support the sales force, and to conduct training seminars to
      educate endoscopists and other health care providers regarding proper use of
      the
      WavSTAT(TM) System, will be a strong component of a product introduction
      strategy.





We
      may
      seek a strategic partner or alliance to further develop and implement product
      introduction, marketing and sales capabilities. We would focus on partners
      with
      large sales forces and established call patterns within Managed Care
      Organizations in the US. We can provide no assurance that we will be able to
      enter into such strategic partnerships on favorable terms or at all. Currently,
      we intend to use distributors in international target markets. The distributors
      should have significant resources and strong franchises which, when coupled
      with
      our technology, will increase the likelihood of commercial success in those
      markets.





Third-Party
      Reimbursement





We
      plan
      to market and sell the WavSTAT(TM) Optical Biopsy System and other products
      primarily through hospitals and clinics. In the United States, the purchasers
      of
      medical devices generally rely on Medicare, Medicaid, private health insurance
      plans, health maintenance organizations and other sources of third party
      reimbursement for health care costs, to reimburse all or part of the cost of
      medical devices and/or the procedure in which the medical device is used. Sales
      of the WavSTAT(TM) System will, in part, be dependent on the availability of
      adequate reimbursement from these third party payors for procedures carried
      out
      using our products. We believe that less invasive procedures generally provide
      less costly overall therapies compared to conventional drugs, surgery and other
      treatments. We anticipate hospital administrators and physicians will justify
      the use of our products by the cost and timesaving recognized and clinical
      benefits that we believe will be derived from the use of our
      products.




-13-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





Third
      party payors determine whether to provide coverage for a particular procedure
      and reimburse health care providers for medical treatment at a fixed rate based
      on the diagnosis-related group established by the Center for Medicare and
      Medicaid Services (“CMS”), formerly known as the Health Care Financing
      Administration (“HCFA”). The fixed rate of reimbursement is based on the
      procedure performed and is unrelated to the specific type or number of devices
      used in a procedure. If a procedure is not covered by a diagnosis-related group,
      payors may deny reimbursement. If reimbursement for a particular procedure
      is
      approved, third party payors will reimburse health care providers for medical
      treatment based on a variety of methods, including a lump sum prospective
      payment system based on a diagnosis-related group or per diem, a blend between
      the health care provider’s reported costs and a fee schedule, a payment for all
      or a portion of charges deemed reasonable and customary, or a negotiated per
      capita fixed payment.





Funding
      for Medicare and Medicaid is subject to limits set by Congress. In 1997, as
      part
      of the Balanced Budget Act of 1997, Congress approved Medicare coverage for
      preventive colorectal cancer screening tests. Diagnosis-related group
      reimbursement for endoscopic procedures such as flexible sigmoidoscopy,
      colonoscopy and polypectomy, including fees for physical biopsies, has been
      established. Because studies have shown that colorectal cancer screening can
      prevent 20%-40% of potential colorectal cancers and 30%-50% of colorectal cancer
      deaths, management believes that such funding should lead to (i) greater
      awareness of colorectal cancer among the general population, (ii) larger budgets
      for screening, (iii) higher reimbursement levels, and (iv) potentially the
      establishment of new reimbursement codes for new technologies like optical
      biopsy of the esophagus. This does not, however, provide any assurances that
      the
      increased funding will lead to third party reimbursement for the WavSTAT(TM)
      System.





Therefore,
      upon product introduction, currently existing available codes can be used to
      provide a level of reimbursement to users. Management believes however, that
      currently available reimbursement codes do not adequately reimburse for the
      anticipated value that optical biopsy technology brings to the medical care
      system. Optical biopsies are not currently approved for reimbursement by
      third-party payors, and there can be no assurance that optical biopsy technology
      will be approved for any third party reimbursement, even if it proves to play
      a
      significant role in improving the endoscopist’s ability to accurately
      differentiate among polyps in the colon or Barrett’s esophagus, thereby leading
      to early detection and subsequent treatment.





Medical
      equipment capital costs incurred by hospitals are reimbursed separately from
      diagnosis-related group payments. Changes in federal legislation, or policies
      of
      the government or third-party payors that reduce reimbursements under capital
      cost pass through systems, could adversely affect the market for our
      products.





As
      stated
      previously, demonstrating cost-effectiveness and improved patient outcomes
      is
      critical to the sales cycle since payers evaluate these factors in determining
      whether to reimburse for new technologies. Payers may also delay reimbursement
      decisions for a year or more, even when provided with cost-effectiveness data,
      while they conduct their own technology assessments. The availability of
      peer-reviewed literature regarding the technology may help payers in reducing
      this technology assessment timeline. To promote the dissemination of literature
      regarding the WavSTAT(TM) System and optical biopsy technology, SpectraScience
      intends to have published clinical utility data in peer-reviewed
      journals.




-14-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





We
      expect
      that there will be continued pressure on cost-containment throughout the United
      States health care system. Cost reduction, cost containment, managed care,
      and
      capitation pricing (putting a ceiling on the price) are very familiar themes
      within healthcare. Limits on third-party reimbursements that lead to cuts in
      reimbursements for new or experimental procedures would affect the ability
      of
      smaller companies with new technologies, to compete with larger established
      firms, or with established technologies. Lobbying activities are often necessary
      to bring to light the value of these new technologies but require extensive
      amounts of corporate resources that the Company may not be able to
      afford.





Reimbursement
      systems in international markets vary significantly by country and by region
      within some countries, and reimbursement approvals must be obtained on a
      country-by-country basis. Many international markets have government managed
      health care systems that control reimbursement for new products and procedures.
      In most markets, there are private insurance systems as well as government
      managed systems. Market acceptance of the SpectraScience products will depend
      on
      the availability and level of reimbursement in international markets we target.
      There can be no assurance that we will obtain reimbursement in any country
      within a particular time, for a particular time, for a particular amount, or
      at
      all.





We
      are
      unable to predict what additional legislation or regulation relating to the
      health care industry or third-party coverage and reimbursement may be enacted
      in
      the future, if any, or what effect it might have on us. Reforms may include
      (i)
      mandated basic health care benefits, (ii) controls on health care spending
      through limitations on the growth of private health insurance premiums and
      Medicare and Medicaid spending, (iii) greater reliance on prospective payment
      systems, (iv) the creation of large insurance purchasing groups, and (v)
      fundamental changes to the health care delivery system. Management anticipates
      that Congress and state legislatures will continue to review and assess
      alternative health care delivery systems and payment mechanisms. Due to
      uncertainties regarding the ultimate features of reform initiatives and their
      enactment and implementation, we cannot predict which reform proposals, if
      any,
      will be adopted, when they may be adopted or what impact they may have on
      SpectraScience. Failure by hospitals and other users of our products to obtain
      reimbursement from third-party payors, or changes in government and private
      third-party payors’ policies toward reimbursement for procedures employing our
      products, could have a material adverse effect on our business, financial
      condition and results of operations.





Manufacturing
      and Sources of Supply





To
      date,
      our manufacturing activities have consisted of assembling a limited number
      of
      WavSTAT(TM) Systems for use in various clinical trials. We do not have
      experience in manufacturing our products in commercial quantities or with the
      yields that will be necessary for us to achieve significant commercial sales.
      Currently, we complete the basic assembly of the WavSTAT(TM) console in-house.
      We assemble the components, all of which are available from more than one
      source, and inspect and test the completed systems at our
      facilities.




-15-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





The
      WavSTAT(TM) System will have to be manufactured in accordance with current
      Quality System Regulations requirements in order for us to sell our products
      in
      the U.S., and ISO 9001 standards in order for us to sell our products in the
      European Union. These requirements impose certain procedural and documentation
      requirements upon us with respect to manufacturing and quality assurance
      activities, as well as upon those third parties with whom we contract to perform
      certain manufacturing processes.





Many
      of
      the raw materials or components used in the manufacture of our products are
“off
      the shelf” items and are available from more than one vendor. However, certain
      components needed for the manufacture of our product, are available only from
      sole or limited source suppliers. The process of qualifying additional or
      replacement vendors for certain components or services can be time-consuming
      and
      expensive, especially in the medical device industry.





We
      currently have an agreement with a contract manufacturer of medical forceps
      in
      the United States, under which they have agreed to supply us with the quantities
      of forceps that we require. This agreement expires upon the expiration of the
      underlying patent. Even though the performance of the suppliers of the forceps
      and other components and raw materials has generally been satisfactory, they
      may
      not continue to perform up to our standards, meet government regulations or
      handle labor unrest, if any.





Competition





The
      medical device industry is highly competitive. Management believes the Company
      has few direct competitors in applying spectroscopy for the differentiation
      of
      normal, pre cancerous or cancerous tissues in the gastrointestinal tract;
      however, the development of products using spectroscopic diagnostics for various
      medical specialties is rapidly growing. To the best of our knowledge, no other
      competitors have completed FDA clinical studies or submitted a pre-market
      approval application to the FDA or received CE Mark authority to distribute
      a
      product for the detection of colorectal or esophageal cancer.





The
      companies listed below have developed or are in the process of developing
      products that use light-based spectroscopic technology. They could potentially
      compete with SpectraScience products or technologies. Although none of these
      companies uses a technology or method which is the same as the SpectraScience
      technologies and methods.





§
            Xillix
                Technologies (Richmond, British Columbia, Canada-OTC:XLLTF.PK) has
                a FDA
                approved product that uses light-based (not laser) spectroscopy for
                detection of cancer in the lungs, which is different from the Company’s
                technologies. The LIFE-Lung system began commercialization in 1998
                at a
                price significantly higher than the Company’s system. Although Xillix is
                focused primarily on the lung application, they have publicly announced
                their intention to expand into the gastrointestinal
                tract.






-16-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**




§
            MediSpectra,
                Inc. (Lexington, MA) has been focused on developing a system that
                improves
                on the current medical standards for cervical cancer detection. The
                system
                consists of an in-vivo, non-contact device that simultaneously uses
                UV
                fluorescence and white light to scan the cervix in a single measurement.
                It then uses the measurement to localize sites for biopsy, the goal
                being
                to detect precursors to cervical cancer. In November 1999, MediSpectra
                announced that preliminary data they collected using their
                second-generation research device correctly identified pre-cancerous
                cervical lesions with an accuracy superior to the current diagnostic
                standard of care. They received FDA clearance to market for this
                indication in March 2006.


§
            Mediscience
                Technology (Cherry Hill, New Jersey-OTC:MDSC.OB) has conducted feasibility
                clinical studies for oral leukopakia, a pre-cancerous condition of
                the
                mouth, with a prototype product called CD SCAN, which uses a light-based
                spectroscopy system. They also plan to conduct clinical studies in
                the
                areas of cervical cancer with products using spectroscopic
                technology.


§
            Electro-Optical
                Sciences, Inc. (Irvington, NY-OTC:MELA) is focused on the design
                and
                development of a non-invasive, point-of-care instrument to assist
                in the
                early diagnosis of melanoma. MelaFind®, features a hand-held imaging
                device that emits multiple wavelengths of light to capture images
                of
                suspicious pigmented skin lesions and extract data. The data is then
                analyzed against its proprietary database of melanomas and benign
                lesions
                using sophisticated algorithms in order to provide information to
                the
                physician and produce a recommendation of whether the lesion should
                be
                biopsied. They are currently designing clinical
                trials.





Many
      of
      these companies have substantially greater resources than we do, either
      internally or in combination with strategic partners. These resources may allow
      them to develop, market and distribute technologies or products that could
      be
      more effective than those developed or marketed by us, or that would render
      our
      technologies and products obsolete. The resource advantages they may have
      are:





§
            greater
                capital resources,


§
            greater
                manufacturing resources,


§
            greater
                resources and expertise in testing products in clinical
                trials,


§
            greater
                resources and expertise in the areas of research and
                development,


§
            greater
                expertise in obtaining regulatory approvals,
                and


§
            greater
                resources for marketing and sales
                activities.





Patents





SpectraScience
      currently owns exclusive rights to a total of eight issued US patents and
      international patents. SpectraScience has eight issued US patents: “Optical
      Biopsy Forceps” (US Patent 5,762,613), “System for Diagnosing Tissue with
      Guidewire” (US Patent 5,601,087), “Method of Diagnosing Tissue with Guidewire”
(US Patent 5,439,000), “Guidewire Catheter and Apparatus for Diagnostic Imaging”
(US Patent 5,383,467), “Optical Biopsy Forceps System and Method of Diagnosing
      Tissue” (US Patent 6,066,102), “Optical Biopsy Forceps” (US Patent 6,129,683),
“Optical Biopsy System and Methods for Tissue Diagnosis” (US Patent 6,174,291),
      and “Optical Forceps System and Method of Diagnosing and Treating Tissue” (US
      Patent 6,394,964). SpectraScience is the exclusive licensee through the
      Massachusetts General Hospital of US Patent 5,843,000 entitled, “Optical Biopsy
      Forceps and Method of Diagnosing Tissue” and a pending international patent
      application. The patents expire between January 2015 and May 2022. Three of
      the
      issued patents and pending patent applications are focused on types of forceps
      having an optical fiber and biopsy jaws which are positioned to take samples
      for
      biopsy or to remove tissue as therapy from the precise area of view of the
      optical fiber, and methods of tissue diagnosis using these forceps. One issued
      patent pertains to the WavSTATTM System and methods of use. The remaining US
      patents pertain to various apparatus and methods of diagnosing tissue, and
      providing the physician with additional information regarding whether it is
      necessary to take a biopsy sample. Each of the international patents designates
      several countries for patent protection. No claims have been brought against
      SpectraScience alleging that the Company's technology or products infringe
      intellectual property rights of others. In October 2005, the Company filed
      a
      provisional patent entitled “System and Method for Non-Endoscopic Optical Biopsy
      Detection of Diseased Tissue”.




-17-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





SpectraScience’s
      ability to obtain and maintain patent protection for its products, preserve
      its
      trade secrets and operate without infringing on the proprietary rights of others
      will directly affect the success the Company's operations. The Company's
      strategy regarding the protection of its proprietary intellectual property
      and
      innovations is to seek patents on those portions of our technology that
      management believes are patentable, to obtain copyrights for its software if
      appropriate, and to protect as trade secrets other confidential information
      and
      proprietary know-how. There are certain technological aspects of the WavSTATTM
System that are not covered by any patents or patent applications.
      SpectraScience seeks to protect its trade secrets and proprietary know-how
      by
      obtaining confidentiality and invention assignment agreements in connection
      with
      employment, consulting and advisory relationships.





Our
      ability to obtain and maintain patent protection for our products, preserve
      our
      trade secrets and operate without infringing on the proprietary rights of others
      will directly affect how successful our operations will be. Our strategy
      regarding the protection of our proprietary rights and innovations is to seek
      patents on those portions of our technology that we believe are patentable,
      and
      to protect as trade secrets other confidential information and proprietary
      know-how.





The
      patent and trade secret positions of medical device companies like
      SpectraScience are uncertain and involve complex and evolving legal and factual
      questions. To date, no claims have been brought against SpectraScience alleging
      that our technology or products infringe intellectual property rights of others.
      Often, patent and intellectual property disputes in the medical device industry
      are settled through licensing or similar arrangements. However, there can be
      no
      assurance that necessary licenses from other parties would be available to
      us on
      satisfactory terms, if at all. The costs associated with such arrangements
      may
      be substantial and could include ongoing royalties. United
      States patent applications are secret until patents are issued or corresponding
      foreign applications are published in other countries. Since publication of
      discoveries in the scientific or patent literature often lags behind actual
      discoveries, management cannot be certain that SpectraScience was the first
      to
      invent the inventions covered by each of its pending patent applications, or
      that it was the first to file patent applications for such inventions. In
      addition, the laws of some foreign countries do not provide the same degree
      of
      intellectual property right protection as do the laws of the United States.
      Litigation associated with patent or intellectual property infringement or
      protection can be lengthy and prohibitively costly. There can be no assurance
      that SpectraScience would have the financial resources to defend its patents
      from infringement or claims of invalidity, or to successfully defend itself
      against intellectual property infringement claims by third parties.




-18-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





Product
      Liability





The
      risk
      of product liability claims, product recalls and associated adverse publicity
      is
      inherent in the testing, manufacturing, marketing and sale of medical products.
      We have clinical trial liability insurance coverage at this time for our current
      Barrett’s esophagus study. There can be no assurance that future insurance
      coverage will be adequate or available. We may not be able to secure product
      liability insurance coverage on acceptable terms or at reasonable costs when
      needed. Any liability for damages could exceed the amount of our coverage.
      A
      successful product liability claim against us could require us to pay a
      substantial monetary award. Moreover, a product recall could generate
      substantial negative publicity about our products and business and inhibit
      or
      prevent commercialization of other future products.





Subsidiaries





We
      have
      no subsidiaries.





Employees





As
      of
      March 22, 2006, SpectraScience had three full-time employees, two involved
      with
      manufacturing and regulatory affairs and one engaged in finance and
      administration. The Company’s payroll is administered through an independent
      third party. SpectraScience is not subject to any collective bargaining
      agreement and management believes that employee relations are generally
      satisfactory.





SpectraScience
      relies heavily on external consultants in the financial, regulatory, software
      development and design engineering areas. When management determines to increase
      our workforce in response to improved economic, market, and/or business
      conditions, there is no assurance that we will be able to attract or retain
      employees with the skills we require.





ITEM
      2. DESCRIPTION OF PROPERTY.





SpectraScience
      leases its principal executive offices from an unrelated third party. The office
      consists of approximately 2,500 square feet of office, research and development,
      manufacturing, quality testing, and warehouse space. The lease provides for
      monthly rental payments of $2,540 through February 2007, plus a pro rata share
      of operating expense and real estate taxes (approximately $467 per month).
      The
      lease expires at the end of February 2007.




-19-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





ITEM
      3. LEGAL PROCEEDINGS.





Reorganization





On
      September 13, 2002, the Company voluntarily filed for bankruptcy protection
      under Chapter 7 of the Bankruptcy Code. After negotiations between the Trustee,
      the Committee, and a potential investor, it was agreed that the case should
      be
      converted to a Chapter 11, reorganization. On February 5, 2003, the Court signed
      an order converting the case to a Chapter 11 case. Negotiations with the
      potential investor ended and a new investor proposed a Plan of Reorganization
      dated May 12, 2004. The bankruptcy court gave final approval to the Plan on
      July
      22, 2004, and the Plan became effective on August 23, 2004. The Company received
      funding and commenced operations effective August 2, 2004. As of August 2,
      2004
      (for purposes of this Report, the “Effective Date”) the Company became the
“Successor Company.” The Company as it existed prior to August 2, 2004, is
      referred to as the “Predecessor Company.”





Under
      the
      Plan, the Company:





§
            settled
                and canceled notes, warrants and monetary claims on August 23, 2004
                of
                $952,570 ($331,270 from the former CEO, $535,000 from note and warrant
                holders and $86,300 in accrued interest) by the issuance of 6,250,020
                shares of common stock.





§
            issued
                11,076,447 shares of common stock to stockholders who participated
                in an
                offering of three new shares of common stock in exchange for one
                outstanding share and $0.24 cash generating cash proceeds of
                $886,116.





§
            issued
                12,384,298 shares to Spectra Acquisition LLC, the sponsor of the
                Plan, in
                satisfaction of a $50,000 investment and as an incentive to carrying
                out
                the Plan.





§
            settled
                claims to vendors of $66,222 through the payment of cash in the amount
                of
                $5,885. The remaining amount of $60,337 was written
                off.





§
            settled
                claims to employees in the amount of $34,762 through the payment
                of cash
                of $6,273. The remaining amount of $28,489 was written
                off.





§
            wrote
                off liabilities in the amount of $108,699 for accrued liabilities
                and
                trade notes payable that was not to be paid as part of the
                Plan.





On
      the
      Effective Date, a new Board of Directors of the reorganized Company consisting
      of four members was established as follows: Jim Hitchin, Mark D. McWilliams,
      Rand P. Mulford and Chester E. Sievert. Subsequent to the Effective Date, Mr.
      Hitchin was elected President, Chief Executive Officer, Secretary and Chief
      Financial Officer. Under the Plan, the Board of Directors shall remain in place
      for three years after the Effective Date at which time the bylaws then in effect
      shall determine elections.




-20-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





We
      adopted fresh-start reporting, as of August 2, 2004, in accordance with SOP
      90-7. Under fresh-start reporting, a new entity has been deemed created for
      financial reporting purposes.





We
      are
      not currently a party to any legal proceedings.





ITEM
      4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
      HOLDERS.





There
      have been no matters submitted to a vote of the security holders since the
      annual meeting held on May 10, 2001 except for a vote on the Plan solicited
      by
      mail during June and July 2004 in the course of the Bankruptcy Court
      proceedings. A majority of the stockholders approved the Plan.





**PART
      II**





ITEM
      5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND
      SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES.





Market
      Information





From
      the
      bankruptcy filing to October 24, 2005, trading of our common stock was reported
      in the “Pink Sheets” under the symbol “SCIE.PK”. Pink Sheets® LLC is a provider
      of pricing and financial information for the over-the-counter (OTC) securities
      markets. Since October 25, 2005 trading of our common stock has been on the
      over-the-counter bulletin board under the symbol SCIE.OB. The last reported
      bid
      price of the common stock on March 22, 2006 was $1.55.





The
      following table sets forth, for the periods indicated, the high and low bid
      prices as reported by the Pink Sheets, from January 1, 2004 Through October
      24,
      2005, and on the OTC Bulletin Board from October 25, 2005 through December
      31,
      2005. To the best of our knowledge, the information obtained from these sources
      is accurate.




2004
                Stock Prices(1)
            
            2005
                Stock Prices(1)QUARTER
                ENDED
            
            High
                Bid
            
            Low
                Bid
            
            High
                Bid
            
            Low
                BidMarch
                31
            
            
            0.12
            
            
            0.01
            
            
            0.93
            
            
            0.80June
                30
            
            
            0.51
            
            
            0.11
            
            
            1.55
            
            
            1.55September
                30
            
            
            0.65
            
            
            0.11
            
            
            1.05
            
            
            0.95December
                31
            
            
            2.00
            
            
            0.19
            
            
            1.48
            
            
            1.25





(1)
            The
                prices of the common stock reflect inter-dealer prices and do not
                necessarily reflect the prices of actual transactions. These prices
                do not
                reflect retail mark-up, mark-down or commission and may not represent
                actual transactions.






-21-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**




Holders





On
      March
      22, 2006 we had approximately 750 registered stockholders of record of
      37,572,262 shares of our common stock, excluding stockholders that are
      registered in “street-names.” We estimate that there are approximately 2,500
      beneficial stockholders of our common stock.





Transfer
      Agent





The
      transfer agent and registrar for our common stock is Wells Fargo Shareowner
      Services, located at 161 N. Concord Exchange, South Saint Paul, Minnesota 55075.
      Their telephone number is (800) 468-9716.





Penny
      Stock





Until
      our
      shares qualify (if ever) for inclusion on an exchange, or in the NASDAQ National
      Market System, the public trading, if any, of our common stock will be on the
      Over-the-Counter Bulletin Board. As a result, an investor may find it difficult
      to dispose of, or to obtain accurate quotations as to the price of, our common
      stock. Our common stock is subject to provisions of Section 15(g) and Rule
      15g-9
      of the Securities Exchange Act of 1934, as amended (the "Exchange Act"),
      commonly referred to as the "penny stock rule." Section 15(g) sets forth certain
      requirements for transactions in penny stocks, and Rule 15g-9(d) incorporates
      the definition of "penny stock" that is found in Rule 3a51-1 of the Exchange
      Act. The SEC generally defines "penny stock" to be any equity security that
      has
      a market price less than $5.00 per share, subject to certain exceptions. So
      long
      as our common stock is deemed to be a penny stock, trading in the shares will
      be
      subject to additional sales practice requirements on broker-dealers who sell
      penny stock to persons other than established customers and accredited
      investors. "Accredited investors" are persons with assets in excess of
      $1,000,000 or annual income exceeding $200,000 or $300,000 together with their
      spouse. For transactions covered by these rules, broker-dealers must make a
      special suitability determination for the purchase of such security and must
      have the purchaser's written consent to the transaction prior to the purchase.
      Additionally, for any transaction involving a penny stock, unless exempt, the
      rules require the delivery, prior to the first transaction, of a risk disclosure
      document, prescribed by the SEC relating to the penny stock market. A
      broker-dealer also must disclose the commissions payable to both the
      broker-dealer and the registered representative, and current quotations for
      the
      securities. Finally, monthly statements must be sent disclosing recent price
      information for the penny stocks held in an account and information on the
      limited market in penny stocks. Consequently, these rules may restrict the
      ability of a broker-dealer to trade and/or maintain a market in our common
      stock
      and may affect the ability of our stockholders to sell their
      shares.





Dividends





To
      date,
      we have not declared or paid cash dividends on our common stock. The current
      policy of the Board of Directors is to retain any earnings to fund the
      development and growth of our business. Consequently, no cash dividends are
      expected to be paid on our common stock in the foreseeable future.




-22-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





Recent
      Sales of Unregistered Securities





The
      Company issued common stock during the fourth quarter of 2005 without
      registration under the Securities Act in connection with a private placement
      of
      securities under Regulation S. The gross proceeds were to be $5,963,832, but
      the
      funds were not received by the time this report was filed. The Company has
      agreed to register these shares with the SEC in 2006, however there is an
      agreement that no shares will be sold for at least one year.




**2006
      Sale of Common Stock**




No.
                of Shares
            8,901,242Type
                of purchasers
            Accredited
                Investors(1)Price/Share
            $0.67Aggregate
                Cash Proceeds
            $5,963,832Exemption
                from Registration
            Regulation
                S of the Securities Act




Shares
      were sold in 2004 under the Plan and otherwise, as described in the following
      table. No agents or underwriters participated and no commission or other
      compensation was paid for placement of the securities.





**2004
      Sale of Common Stock**





**Private
                Placement**
            **Chapter
                11 Plan**No.
                of Shares
            4,378,333
            29,710,766(2)Type
                of purchasers
            Accredited
                Investors(1)
            Participants
                in Rights Offering, Claimants, Plan Sponsor(2)Price/Share
            $0.12
            See
                Note(2),
                belowAggregate
                Cash Proceeds
            $525,400
            $936,116Exemption
                from Registration
            Sections
                4(2) and 4(6) of the Securities Act and Regulation D
            §1145
                of the Bankruptcy Act








1.
            As
                defined in Regulation D under the Securities
                Act.


2.
            In
                the Rights Offering a holder of common stock was required to exchange
                one
                share and $0.24 for three new shares. The trading price of the common
                stock during the Rights Offering ranged from approximately $0.12
                to $0.45.
                11,076,447 shares were issued in the Rights Offering in August 2004.
                Creditors consisted of the former CEO (600,000 shares) and Noteholders
                and
                warrant holders (5,650,020 shares). The price paid by them was
                extinguishment of all claims (approximately $0.10 per share). SA
                LLC, the
                Plan Sponsor, received 12,384,298 shares, consisting of 5,000,000
                of
                common stock issued at $0.01 per share and the balance in connection
                with
                the level of success of the Rights
                Offering.






-23-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**
  ITEM
        6. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF
        OPERATION





The
      following discussion and analysis provides information that management believes
      is relevant to assess and understand our results of operations and financial
      condition. This discussion should be read in conjunction with the financial
      statements and footnotes that follow such financial statements.





Certain
      statements contained herein that are not related to historical results,
      including, without limitation, statements regarding the Company's business
      strategy and objectives, future financial position, expectations about pending
      litigation and estimated cost savings, are forward-looking statements within
      the
      meaning of Section 27A of the Securities Act and Section 21E of the Securities
      Exchange Act of 1934, as amended (the "Securities Exchange Act") and involve
      risks and uncertainties. Although we believe that the assumptions on which
      these
      forward-looking statements are based are reasonable, there can be no assurance
      that such assumptions will prove to be accurate and actual results could differ
      materially from those discussed in the forward-looking statements. Factors
      that
      could cause or contribute to such differences include, but are not limited
      to,
      regulatory policies, competition from other similar businesses, and market
      and
      general economic factors. All forward-looking statements contained in this
      Form
      10-KSB are qualified in their entirety by this statement.





Reorganization





On
      September 13, 2002, the Company voluntarily filed for bankruptcy protection
      under Chapter 7 of the Bankruptcy Code. After negotiations between the Trustee,
      the Committee, and a potential investor, it was agreed that the case should
      be
      converted to a Chapter 11 reorganization. On February 5, 2003, the Court signed
      an order converting the case to a Chapter 11 case. Negotiations with the
      potential investor ended and a new investor proposed a Plan of Reorganization
      dated May 12, 2004. The bankruptcy court gave final approval to the Plan of
      Reorganization (the “Plan”) on July 22, 2004, and the Plan became effective on
      the August 23, 2004. The Company received funding and commenced operations
      effective August 2, 2004. As of August 2, 2004 (for purposes of this Report,
      the
“Effective Date”) the Company became the “Successor Company.” The Company as it
      existed prior to August 2, 2004, is referred to as the “Predecessor
      Company.”




-24-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





Under
      the
      Plan, the Company:





§
            settled
                and canceled notes, warrants and monetary claims on August 23, 2004
                of
                $952,570 ($331,270 from the former CEO, $535,000 from note and warrant
                holders and $86,300 in accrued interest) by the issuance of 6,250,020
                shares of common stock.





§
            issued
                11,076,447 shares of common stock to stockholders who participated
                in an
                offering of three new shares of common stock in exchange for one
                outstanding share and $0.24 cash generating cash proceeds of
                $886,116.





§
            issued
                12,384,298 shares to Spectra Acquisition LLC, the sponsor of the
                Plan, in
                satisfaction of a $50,000 investment and as an incentive to carrying
                out
                the Plan.





§
            settled
                claims to vendors of $66,222 through the payment of cash in the amount
                of
                $5,885. The remaining amount of $60,337 was written
                off.





§
            settled
                claims to employees in the amount of $34,762 through the payment
                of cash
                of $6,273. The remaining amount of $28,489 was written
                off.





§
            wrote
                off liabilities in the amount of $108,699 for accrued liabilities
                and
                trade notes payable that was not to be paid as part of the
                Plan.





On
      the
      Effective Date, a new Board of Directors of the reorganized Company consisting
      of four members was established as follows: Jim Hitchin, Mark D. McWilliams,
      Rand P. Mulford and Chester E. Sievert. Subsequent to the Effective Date, Mr.
      Hitchin was elected President, Chief Executive Officer, Secretary and Chief
      Financial Officer. Under the Plan, the Board of Directors shall remain in place
      for three years after the Effective Date at which time the bylaws then in effect
      shall determine elections.





We
      adopted fresh-start reporting, as of August 2, 2004, in accordance with the
      American Institute of Certified Public Accountants Statement of Position 90-7,
      Financial Reporting by Entities in Reorganization Under the Bankruptcy Code
      (SOP
      90-7). Under fresh-start reporting, a new entity has been deemed created for
      financial reporting purposes.





*Fresh-Start
      Adjustments.* Fresh-start valuation adjustments were recorded pursuant to the provisions
      of
      SOP 90-7, which require entities to record their assets and liabilities at
      estimated fair values. The fresh-start valuation adjustment is principally
      the
      result of the elimination of predecessor company accumulated deficit and the
      revaluation of inventory, fixed assets and intangible assets to estimated fair
      values.





*Gain
      on Debt Discharge.* During
      the 2004 period, reorganization gain on debt discharge of $525,380 was recorded
      in accordance with the implementation of the Plan.




-25-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





Plan
      of Operation





For
      the
      three years immediately preceding its bankruptcy filing, SpectraScience focused
      on the design, development, clinical testing, regulatory approval, and initial
      commercialization of the WavSTAT(TM) I System. Additionally, the Company
      obtained regulatory approval of WavSTAT(TM) II, and WavSTAT(TM) III. In addition
      to designing, developing and testing its next generation products,
      SpectraScience developed in 2000 a second application for detection of Barrett’s
      esophagus.





SpectraScience
      spent significant amounts of effort on multiple clinical outcome studies
      necessary to gain reimbursement, but never sought reimbursement codes.
      SpectraScience must have cost effectiveness data for the WavSTAT(TM) System
      to
      present to CMS and other governmental agencies in order to obtain reimbursement
      codes. Cost effectiveness data is collected through outcome based clinical
      studies. In addition, this same data is one of several pieces of information
      that managed care will require when making a buy decision. The secondary
      accomplishments of the outcome based clinical studies are integrated with our
      marketing efforts. They provide an opportunity to demonstrate to key opinion
      leaders the clinical utility and ease of use of the WavSTAT(TM) System.
      Management believes this in turn should help drive clinical
      acceptance.





SpectraScience
      had no operations from September 13, 2002 through August 2, 2004 except for
      payments necessary to preserve its patents, legal standing and other assets
      of
      its Estate in bankruptcy. The Successor Company in anticipation of emergence
      from bankruptcy began a Regulation D offering in June and July of 2004. Funds
      totaling $505,400 from this offering were deposited to the Company’s new bank
      account at that time in exchange for 4,211,666 shares of stock.





In
      2005,
      the Company became current in its SEC filings. We also submitted a PMA
      Supplement with the FDA to register its San Diego facility. An earlier study
      to
      determine if the Company’s WavSTAT(TM) System is suitable for detecting
      Barrett’s esophagus was restarted. We expect this study to be completed in
      2006.





During
      the next year SpectraScience intends to:





§
            complete
                Phase II clinical studies with our Barrett’s esophagus
                application,


§
            file
                a supplement with the FDA for this new indication for
                use,


§
            continue
                to develop the market with key physician opinion leaders, both
                international and domestic, for our approved product as well as for
                a
                Barrett’s esophagus application,


§
            begin
                sales both domestically and
                internationally,


§
            develop
                strategic relationships for distribution and marketing and complete
                outcome based clinical studies for the colon application,
                and


§
            submit
                to CMS, an application for reimbursement codes for use of the WavSTAT(TM)
                System upon completion of an outcome based clinical
                study.






-26-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**


We
      do not
      anticipate any significant purchase or sale of plant and significant equipment
      or any significant changes in the number of employees other than a proportional
      increase in operational employees and sales people consistent with our
      increasing revenue (if any).





Cash
      on
      hand as of August 2, 2004, the date the Company emerged from bankruptcy was
      $1,441,990. Cash on hand as of December 31, 2004 was $1,132,505. Cash on hand
      as
      of December 31, 2005 was $441,025.





Liquidity
      and Capital Resources





SpectraScience
      has financed its operations since 1992 principally through private placements
      of
      its common and preferred stock. From October 1992, when we began development
      of
      our current products and changed our name, until December 31, 2001, we had
      obtained funds aggregating approximately $16 million in net proceeds from the
      issuance of common stock and preferred stock. As of December 31, 2004
      SpectraScience had cash and cash equivalents of $1,132,505.


The
      cash
      position as of December 31, 2004 is the result of the receipt of proceeds of
      $886,116 in a stockholder rights offering under the Company’s Chapter 11 Plan,
      $50,000 in proceeds as part of the Plan of Reorganization, and $525,400 in
      a
      private placement to “accredited investors”, as defined in Regulation D under
      the Securities Act of 1933. Cash provided by financing operating activities
      totaled $3,225 during the year ended December 31, 2005 and cash and cash
      equivalents as of December 31, 2005 totaled $441,025.





SpectraScience
      expects to incur significant additional operating losses through at least 2006,
      as we complete a current clinical trial, begin outcome-based clinical studies,
      research and development activities continue, and sales and marketing efforts
      to
      commercialize the WavSTAT(TM) System begin. Company management anticipates
      that
      it will have sufficient cash and cash equivalents to fund operations to
      profitability if the 2006 funding is received in the second quarter of
      2006.





SpectraScience’s
      future liquidity and capital requirements will depend upon a number of factors,
      including but not limited to:





§
            the
                timing and progress of outcome-based clinical
                trials,


§
            the
                timing and extent to which SpectraScience’s products gain market
                acceptance,


§
            the
                timing and expense of product
                introduction,


§
            the
                timing and expense of developing marketing and distribution
                channels,


§
            the
                progress and expense of developing next generation products and new
                applications for the WavSTAT(TM)
                System,


§
            the
                potential requirements and related costs for product modifications,
                the
                timing and expense of various U.S. and foreign regulatory
                filings,


§
            the
                maintenance of various U.S. and foreign government approvals, or
                the
                timing of receipt to obtain additional approvals,
                and


§
            the
                status and maintenance of SpectraScience’s patent
                portfolio.






-27-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**




The
      Company re-commenced operations after confirmation of its Plan on August 2,
      2004
      (the “Effective Date” for purposes of this report). For financial statement
      purposes, the Company's results of operations and cash flows have been separated
      before and after the Effective Date due to the change in basis of accounting
      in
      the underlying assets and liabilities resulting from application of fresh-start
      reporting. To facilitate a meaningful comparison of the Company's performance,
      the following discussion of results of operations is presented on a traditional
      comparative basis for both periods, except where fresh-start reporting prevents
      comparability with the prior period. Accordingly, the results of operations
      present the Predecessor Company for the period January 1, 2004 to August 1,
      2004
      and the Successor Company for the period August 2, 2004 to December 31, 2004
      and
      January 1, 2005 to December 31, 2005. Management does not believe that a
      discussion of Predecessor Company and Successor Company periods is reasonable
      or
      appropriate in many areas due to lack of comparability for accounting purposes,
      in accordance with SOP 90-7. Where appropriate, a discussion is
      included.





Historical
      Results of Operations





The
      following discussion should be read in conjunction with the financial statements
      and the related notes thereto included in this report.





***Fiscal
      Year Ended December 31, 2005 As Compared To Fiscal Year Ended December 31,
      2004***





Gross
      Revenue


The
      Company had no revenue in either period.





Operating
      Loss


Losses
      increased $433,233 in 2005 to $928,079 compared to $494,846 in 2004 as
      additional research and development and general administrative expenses were
      incurred to re-start the Company in 2005. The increase in research and
      development costs of $53,122 was due to the fact that there were no research
      and
      development costs during 2004. The increase in general and administrative
      expense in 2005 of $380,111 was due to professional fees and payroll which
      were
      $370,300 and $318,404, respectively. This increase was due to a full year of
      expenses during 2005 and audit fees during 2005 of approximately
      $131,000.





Other
      Income (Expense)


For
      the
      year ended December 31, 2005, other income was $15,791 principally due to
      interest income on cash balances. For the year ended December 31, 2004, other
      expenses were $13,627, principally due to the accrual of interest expense due
      on
      notes payables in 2004. In 2004, the notes payables were converted to common
      stock as a result of the Plan.




Liquidity
      and Capital Resources


On
      December 31, 2005, the Company had cash of $441,025 compared to $1,132,505
      at
      December 31, 2004 representing a decrease of $691,480. The cash decreased due
      to
      expenses incurred in re-starting the Company, principally in salaries and
      professional fees. In the second quarter of 2006, the Company expects
      to receive payment for its previously placed common shares for
      approximately $6,000,000 in gross proceeds with net proceeds of
      $5,427,087.




-28-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**




Operating
      Activities


During
      the years ended December 31, 2005 and 2004, operating activities used net cash
      of $694,705 and $410,738, respectively, primarily due to payment of professional
      fees and payroll.





Investing
      Activities


There
      were no investing activities for the year ended December 31, 2005. Investing
      activities provided $8,240 in the year ended December 31, 2004 due to the sale
      of fixed assets.





Financing
      Activities


For
      the
      year ended December 31, 2005, financing activities provided $3,225 due to the
      exercise of 21,500 employee stock options. Subsequent to December 31, 2005,
      the
      Company issued 8,901,242 common shares. The Company expects to receive
      payment for these previously placed shares to be approximately $6,000,000.
      Financing in 2004 consisted of proceeds of $886,116 in a stockholder rights
      offering under the Company’s Chapter 11 Plan, $50,000 in proceeds as part of the
      Plan, and $525,400 in a private placement to accredited investors.





Working
      Capital


Decreases
      in working capital during the year ended December 31, 2005 in the amount of
      $725,471 was due to increased expenses in re-starting the Company, principally
      in research and development, payroll and professional fees. Increases in working
      capital during the year ended December 31, 2004 in the amount of $2,254,931
      was
      due to settlement of debts through the Plan and common stock
      issuances.








Critical
      Accounting Policies and Estimates


The
      discussion and analysis of our financial condition and results of operations
      are
      based upon our financial statements, which have been prepared in accordance
      with
      accounting principles generally accepted in the United States of America. The
      preparation of these financial statements requires us to make estimates and
      judgments that affect the reported amounts of assets, liabilities, revenues
      and
      expenses and related disclosure of contingent assets and liabilities. On an
      on-going basis, we evaluate these estimates, including those related to bad
      debts, intangibles, income taxes, financing operations, contingencies and
      litigation. We base our estimates on historical experience and on various other
      assumptions that are believed to be reasonable under the circumstances, the
      results of which form the basis for making judgments about the carrying values
      of assets and liabilities that are not readily apparent from other sources.
      Actual results may differ from these estimates under different assumptions
      or
      conditions.





We
      have
      identified the policies below as critical to our business operations and the
      understanding of our results of operations. The impact and any associated risks
      related to these policies on our business operations is discussed throughout
      Management's Discussion and Analysis or Plan of Operation where such policies
      affect our reported and expected financial results. Note that our preparation
      of
      this Report on Form 10-KSB requires us to make estimates and assumptions that
      affect the reported amount of assets and liabilities, disclosure of contingent
      assets and liabilities at the date of our financial statements, and the reported
      amount of revenue, if any, and expenses during the reporting period. There
      can
      be no assurance that actual results will not differ from those
      estimates.




-29-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





*Fresh-Start
      Reporting*





Upon
      emerging from Chapter 11 proceedings, we adopted fresh-start reporting in
      accordance with the American Institute of Certified Public Accountants Statement
      of Position 90-7, Financial Reporting by Entities in Reorganization Under the
      Bankruptcy Code (SOP 90-7). In connection with the adoption of fresh-start
      reporting, a new entity has been deemed created for financial reporting
      purposes. For financial reporting purposes, we adopted the provisions of
      fresh-start reporting effective August 2, 2004. Consequently, the balance sheet
      and related information as of December 31, 2005 and 2004 is considered the
      “Successor Company,” and reflects the Plan of Reorganization and the principles
      of fresh-start reporting. Periods presented prior to August 2, 2004 are
      considered the “Predecessor Company.” References to operating results and cash
      flows for periods ended prior to August 2, 2004 refer to the operating results
      and cash flows of the Predecessor Company, and references to working capital
      and
      other balance sheet data, liquidity and prospective information regarding future
      periods refer to the Successor Company. SOP 90-7.40 states, “comparative
      financial statements that straddle a confirmation date should not be presented.”
We have done so where possible to aid in the understanding of Company
      activities.





Recent
      Accounting Pronouncements





*Accounting
      For Transactions Involving Stock Compensation*


In
      December 2004, the FASB issued SFAS 123(R) (revised 2004), "Share-Based
      Payment", which amends FASB Statement No. 123 and will be effective for public
      companies for annual periods beginning after December 15, 2005. The new standard
      will require us to expense employee stock options and other share-based
      payments. Since inception on August 2, 2004, the Company has been recording
      to
      expense the fair value of employee and non-employee options. The application
      of
      SFAS 123(R) is not expected to have a material impact on our financial
      statements.





*Impairment
      or Disposal of Long-Lived Assets*





SFAS
      144,
      addresses financial accounting and reporting for the impairment or disposal
      of
      long-lived assets (such as our patents). SFAS 144 requires that long-lived
      assets be reviewed for impairment whenever events or changes in circumstances
      indicate that their carrying amounts may not be recoverable. If the cost basis
      of a long-lived asset is greater than the projected future undiscounted net
      cash
      flows from such asset (excluding interest), an impairment loss is recognized.
      Impairment losses are calculated as the difference between the cost basis of
      an
      asset and its estimated fair value. SFAS 144 also requires companies to
      separately report discontinued operations and extends that reporting requirement
      to a component of an entity that either has been disposed of (by sale,
      abandonment or in a distribution to owners) or is classified as held for sale.
      Assets to be disposed of are reported at the lower of the carrying amount or
      the
      estimated fair value less costs to sell. The Company adopted SFAS 144 on August
      2, 2004. The provisions of this pronouncement relating to assets held for sale
      or other disposal generally are required to be applied prospectively after
      the
      adoption date to newly initiated commitments to plan to sell or dispose of
      such
      asset, as defined, by management. As a result, management cannot determine
      the
      potential effects that adoption of SFAS 144 will have on the Company's financial
      statements with respect to future disposal decisions, if any. Management
      believes no impairment exists at December 31, 2005.




-30-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





*Inventory
      Costs*





In
      November 2004, the FASB issued SFAS 151, Inventory Costs, and an amendment
      of
      ARB No. 43, Chapter 4. This statement amends the guidance in ARB No. 43, Chapter
      4, Inventory Pricing, to clarify the accounting for abnormal amounts of idle
      facility expense, freight, handling costs, and wasted material (spoilage).
      Paragraph 5 of ARB No. 43, Chapter 4, previously stated "under some
      circumstances, items such as idle facility expense, excessive spoilage, double
      freight, and rehandling costs may be so abnormal as to require treatment as
      current period charges." SFAS 151 requires that those items be recognized
      as current-period charges regardless of whether they meet the criterion of
      "so
      abnormal.” In addition, this statement requires that allocation of fixed
      production overheads to the costs of conversion be based on the normal capacity
      of the production facilities. The provisions of SFAS 151 shall be applied
      prospectively and are effective for inventory costs incurred during fiscal
      years
      beginning after June 15, 2005 with earlier application permitted for inventory
      costs incurred during fiscal years beginning after the date this statement
      was
      issued. The adoption of SFAS 151 did not have a material impact on our financial
      position and results of operations.





*Exchanges
      of Nonmonetary Assets*





In
      December 2004, the FASB issued SFAS 153, Exchanges of Nonmonetary Assets, an
      amendment of APB Opinion No. 29. The guidance in APB Opinion No. 29, Accounting
      for Nonmonetary Transactions, is based on the principle that exchanges of
      nonmonetary assets should be measured based on the fair value of assets
      exchanged. The guidance in that Opinion, however, included certain exceptions
      to
      that principle. This statement amends Opinion 29 to eliminate the exception
      for
      nonmonetary exchanges of similar productive assets that do not have commercial
      substance. A non-monetary exchange has commercial substance if the future cash
      flows of the entity are expected to change significantly as a result of the
      exchange. SFAS 153 is effective for nonmonetary exchanges occurring in fiscal
      periods beginning after June 15, 2005. The adoption of SFAS 153 did not have
      a
      material impact on our financial position and results of operations.





**Risks**




We
      have
      described below a number of uncertainties and risks which, in addition to
      uncertainties and risks presented elsewhere in this annual report may adversely
      affect our business, operating results and financial condition. The
      uncertainties and risks enumerated below as well as those presented elsewhere
      in
      this annual report should be considered carefully in evaluating our company
      and
      our business and the value of our securities.




-31-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





WE
      HAVE
      ACCUMULATED LOSSES SINCE OUR INCEPTION, AND CURRENTLY HAVE NO PRODUCTS OR
      SERVICES ON THE MARKET THAT ARE CURRENTLY GENERATING REVENUES.





Our
      inability to generate revenues and profits from products we have recently
      introduced onto the market could cause us to go out of business and could cause
      our stockholders to lose their entire investment. We have not had any revenues
      for the past four years. To date, we have engaged primarily in research,
      development and clinical testing. Since the beginning of the Successor Period,
      we have not been profitable, and we cannot be certain that we will ever achieve
      or sustain profitability. We have incurred a cumulative net loss in the amount
      of $1,289,979 from the beginning of the Successor Period through December 31,
      2005. We have no products or services on the market that are currently
      generating revenues. Our failure to generate meaningful revenues and ultimately
      profits from potential products and applications of our technology could force
      us to raise additional capital which may not be available or available on
      acceptable terms. This could ultimately reduce or suspend our operations and
      ultimately go out of business. Developing our product candidates will require
      significant additional research and development, including non-clinical testing
      and clinical trials, as well as regulatory approval. We expect these activities,
      together with our general and administrative expenses, to result in operating
      losses for the foreseeable future.





WE
      MAY
      FACE INTENSE COMPETITION FROM COMPANIES THAT HAVE GREATER FINANCIAL, PERSONNEL
      AND RESEARCH AND DEVELOPMENT RESOURCES THAN OURS.





These
      competitive forces may impact our projected growth and ability to generate
      revenues and profits, which would have a negative impact on our business and
      the
      value of your investment. Our competitors may be developing products, which
      could compete with the WavSTAT(TM) System we are developing. Our commercial
      opportunities will be reduced or eliminated if our competitors develop and
      market products for any of the diseases that we target that are





§
            are
                more effective;


§
            or
                are less expensive than the products or product candidates we are
                developing.





Even
      if
      we are successful in developing effective WavSTAT(TM) Systems, and obtain FDA
      and other regulatory approvals necessary for commercializing them, our products
      may not compete effectively with other successful products. Researchers are
      continually learning more about diseases, which may lead to new technologies
      and
      tools for analysis. Our competitors may succeed in developing and marketing
      products either that are more effective than those that we may develop, alone
      or
      with our collaborators, or that are marketed before any products we develop
      are
      marketed.





Our
      competitors may include fully integrated medical device companies, universities
      and public and private research institutions. Many of the organizations
      competing with us, have substantially greater capital resources, larger research
      and development staffs and facilities, greater experience in product development
      and in obtaining regulatory approvals, and greater marketing capabilities than
      we do.




-32-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





The
      market for medical devices is intensely competitive. Many of our potential
      competitors have longer operating histories, greater name recognition, more
      employees, and significantly greater financial, technical, marketing, public
      relations, and distribution resources than we have. This intense competitive
      environment may require us to make changes in our products, pricing, licensing,
      services or marketing to develop, maintain and extend our current technology.
      Price concessions or the emergence of other pricing or distribution strategies
      of competitors may diminish our revenues, adversely impact our margins or lead
      to a reduction in our market share, any of which may harm our
      business.





OUR
      WavSTAT(TM) SYSTEM TECHNOLOGY MAY BECOME OBSOLETE.





Our
      WavSTAT(TM) System products may be made unmarketable by new scientific or
      technological developments where new treatment modalities are introduced that
      are more efficacious or more economical than our WavSTAT(TM) System products.
      Any one of our competitors could develop a more effective product which would
      render our technology obsolete.





WE
      ARE
      DEPENDENT FOR OUR SUCCESS ON A KEY EXECUTIVE OFFICER.





Our
      success depends to a critical extent on the continued services of our Chief
      Executive Officer, Jim Hitchin. If we lost this key executive officer, we would
      be forced to expend significant time and money in the pursuit of a replacement,
      which would result in both a delay in the implementation of our business plan
      and the diversion of limited working capital. We can give you no assurance
      that
      we could find a satisfactory replacement for this key executive officer at
      all,
      or on terms that are not unduly expensive or burdensome. We do not have an
      employment agreement with Mr. Hitchin and his employment is severable by either
      party at will. We currently carry a key man life insurance policy on him in
      the
      amount of $2,000,000.





OUR
      INABILITY TO ATTRACT AND RETAIN QUALIFIED PERSONNEL COULD IMPEDE OUR ABILITY
      TO
      GENERATE REVENUES AND PROFITS AND TO OTHERWISE IMPLEMENT OUR BUSINESS PLAN
      AND
      GROWTH STRATEGIES, WHICH WOULD HAVE A NEGATIVE IMPACT ON OUR BUSINESS AND COULD
      ADVERSELY AFFECT THE VALUE OF YOUR INVESTMENT.





We
      currently have an extremely small staff comprised of 3 full time employees
      consisting of our Chief Executive Officer, our Operations Manager and a Clinical
      Studies/Product Engineer/Manager as well as other personnel employed on a
      contract basis. Although we believe that these employees, together with the
      consultants currently engaged by the Company, will be able to handle most of
      our
      additional administrative, research and development and business development
      in
      the near term, we will nevertheless be required over the longer-term to hire
      highly skilled managerial, scientific and administrative personnel to fully
      implement our business plan and growth strategies. We cannot assure you that
      we
      will be able to engage the services of such qualified personnel at competitive
      prices or at all, particularly given the risks of employment attributable to
      our
      limited financial resources and lack of an established track
      record.




-33-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





WE
      PLAN
      TO GROW VERY RAPIDLY, WHICH WILL PLACE STRAINS ON OUR MANAGEMENT TEAM AND OTHER
      COMPANY RESOURCES TO BOTH IMPLEMENT MORE SOPHISTICATED MANAGERIAL, OPERATIONAL
      AND FINANCIAL SYSTEMS, PROCEDURES AND CONTROLS AND TO TRAIN AND MANAGE THE
      PERSONNEL NECESSARY TO IMPLEMENT THOSE FUNCTIONS. OUR INABILITY TO MANAGE OUR
      GROWTH COULD IMPEDE OUR ABILITY TO GENERATE REVENUES AND PROFITS AND TO
      OTHERWISE IMPLEMENT OUR BUSINESS PLAN AND GROWTH STRATEGIES, WHICH WOULD HAVE
      A
      NEGATIVE IMPACT ON OUR BUSINESS AND THE VALUE OF YOUR INVESTMENT.





We
      will
      need to significantly expand our operations to implement our longer-term
      business plan and growth strategies. We will also be required to manage multiple
      relationships with various strategic partners, technology licensors, customers,
      manufacturers and suppliers, consultants and other third parties. This expansion
      and these expanded relationships will require us to significantly improve or
      replace our existing managerial, operational and financial systems, procedures
      and controls; to improve the coordination between our various corporate
      functions; and to manage, train, motivate and maintain a growing employee base.
      The time and costs to effectuate these steps may place a significant strain
      on
      our management personnel, systems and resources, particularly given the limited
      amount of financial resources and skilled employees that may be available at
      the
      time. We cannot assure you that we will institute, in a timely manner or at
      all,
      the improvements to our managerial, operational and financial systems,
      procedures and controls necessary to support our anticipated increased levels
      of
      operations and to coordinate our various corporate functions, or that we will
      be
      able to properly manage, train, motivate and retain our anticipated increased
      employee base.





WE
      MAY
      HAVE DIFFICULTY IN ATTRACTING AND RETAINING MANAGEMENT AND OUTSIDE INDEPENDENT
      MEMBERS TO OUR BOARD OF DIRECTORS AS A RESULT OF THEIR CONCERNS RELATING TO
      THEIR INCREASED PERSONAL EXPOSURE TO LAWSUITS AND STOCKHOLDER CLAIMS BY VIRTUE
      OF HOLDING THESE POSITIONS IN A PUBLICLY-HELD COMPANY.





The
      directors and management of publicly traded corporations are increasingly
      concerned with the extent of their personal exposure to lawsuits and stockholder
      claims, as well as governmental and creditor claims which may be made against
      them, particularly in view of recent changes in securities laws imposing
      additional duties, obligations and liabilities on management and directors.
      Due
      to these perceived risks, directors and management are also becoming
      increasingly concerned with the availability of directors and officers liability
      insurance to pay on a timely basis the costs incurred in defending such claims.
      We currently do carry directors and officers liability insurance. Directors
      and
      officers liability insurance has recently become much more expensive and
      difficult to obtain. If we are unable to obtain directors and officers liability
      insurance at affordable rates or at all, in the future, it may become
      increasingly more difficult to attract and retain qualified outside directors
      to
      serve on our board of directors. The fees of directors are also rising in
      response to their increased duties, obligations and liabilities as well as
      increased exposure to such risks. As a company with a limited operating history
      and limited resources, we will have a more difficult time attracting and
      retaining management and outside independent directors than a more established
      company due to these enhanced duties, obligations and liabilities.




-34-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





IF
      WE
      FAIL TO COMPLY WITH EXTENSIVE REGULATIONS ENFORCED BY DOMESTIC AND FOREIGN
      REGULATORY AUTHORITIES, THE COMMERCIALIZATION OF OUR PRODUCT CANDIDATES COULD
      BE
      PREVENTED OR DELAYED.





Our
      WavSTAT(TM) System is subject to extensive government regulations related to
      development, testing, manufacturing and commercialization in the United States
      and other countries. The determination of when and whether a product is ready
      for large scale purchase and potential use will be made by the government
      through consultation with a number of governmental agencies, including the
      FDA,
      the National Institutes of Health, and the Centers for Disease Control and
      Prevention. Our product candidates are in the clinical stages of development
      and
      have not received required regulatory approval from the FDA for an esophageal
      application we hope to commercially market. The process of obtaining and
      complying with FDA and other governmental regulatory approvals and regulations
      is costly, time consuming, uncertain and subject to unanticipated delays.
      Despite the time and expense exerted, regulatory approval is never guaranteed.
      We also are subject to the following risks and obligations, among
      others.





§
            The
                FDA may refuse to approve an application if they believe that applicable
                regulatory criteria are not
                satisfied.


§
            The
                FDA may require additional testing for safety and
                effectiveness.


§
            The
                FDA may interpret data from pre-clinical testing and clinical trials
                in
                different ways than we interpret
                them.


§
            If
                regulatory approval of a product is granted, the approval may be
                limited
                to specific indications or limited with respect to its
                distribution.


§
            The
                FDA may change their approval policies and/or adopt new
                regulations.





Failure
      to comply with these or other regulatory requirements of the FDA may subject
      us
      to administrative or judicially imposed sanctions, including:





§
            warning
                letters;


§
            civil
                penalties;


§
            criminal
                penalties;


§
            injunctions;


§
            product
                seizure or detention;


§
            product
                recalls; and


§
            total
                or partial suspension of
                productions.





DELAYS
      IN
      SUCCESSFULLY COMPLETING OUR CLINICAL TRIALS COULD JEOPARDIZE OUR ABILITY TO
      OBTAIN REGULATORY APPROVAL OR MARKET OUR WavSTAT(TM) SYSTEM CANDIDATE ON A
      TIMELY BASIS.





Our
      business prospects will depend on our ability to complete clinical trials,
      obtain satisfactory results, obtain required regulatory approvals and
      successfully commercialize our WavSTAT(TM) System product candidate. Completion
      of our clinical trials, announcement of results of the trials and our ability
      to
      obtain regulatory approvals could be delayed for a variety of reasons,
      including:





§
            unsatisfactory
                results of any clinical trial;


§
            the
                failure of our principal third-party investigators to perform our
                clinical
                trials on our anticipated
                schedules;


§
            different
                interpretations of our pre-clinical and clinical data, which could
                initially lead to inconclusive
                results.






-35-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**




OUR
      DEVELOPMENT COSTS WILL INCREASE IF WE HAVE MATERIAL DELAYS IN ANY CLINICAL
      TRIAL
      OR IF WE NEED TO PERFORM MORE OR LARGER CLINICAL TRIALS THAN
      PLANNED.





If
      the
      delays are significant, or if any of our WavSTAT(TM) System product candidates
      do not prove to be safe or effective or do not receive required regulatory
      approvals, our financial results and the commercial prospects for our product
      candidates will be harmed. Furthermore, our inability to complete our clinical
      trials in a timely manner could jeopardize our ability to obtain regulatory
      approval.





THE
      INDEPENDENT CLINICAL INVESTIGATORS THAT WE RELY UPON TO CONDUCT OUR CLINICAL
      TRIALS MAY NOT BE DILIGENT, CAREFUL OR TIMELY, AND MAY MAKE MISTAKES, IN THE
      CONDUCT OF OUR CLINICAL TRIALS.





We
      depend
      on independent clinical investigators to conduct our clinical trials. The
      investigators are not our employees, and we cannot control the amount or timing
      of resources that they devote to our product development programs. If
      independent investigators fail to devote sufficient time and resources to our
      product development programs, or if their performance is substandard, it may
      delay FDA approval of our products. These independent investigators may also
      have relationships with other commercial entities, some of which may compete
      with us. If these independent investigators assist our competitors at our
      expense, it could harm our competitive position.





OUR
      PRODUCT DEVELOPMENT EFFORTS MAY NOT YIELD MARKETABLE PRODUCTS DUE TO RESULTS
      OF
      STUDIES OR TRIALS, FAILURE TO ACHIEVE REGULATORY APPROVALS OR MARKET ACCEPTANCE,
      PROPRIETARY RIGHTS OF OTHERS OR MANUFACTURING ISSUES.





Our
      success depends on our ability to successfully develop and obtain regulatory
      approval to market new products. We expect that a significant portion of the
      research that we will conduct will involve new and unproven technologies.
      Development of a product requires substantial technical, financial and human
      resources even if the product is not successfully completed.





Our
      potential products may appear to be promising at various stages of development
      yet fail to reach the market for a number of reasons, including
      the:





§
            lack
                of adequate quality or sufficient prevention benefit, or unacceptable
                safety during pre-clinical studies or clinical
                trials;


§
            failure
                to receive necessary regulatory
                approvals;


§
            existence
                of proprietary rights of third parties;
                and/or


§
            inability
                to develop manufacturing methods that are efficient, cost-effective
                and
                capable of meeting stringent regulatory
                standards.






-36-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**




OUR
      INABILITY TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS COULD NEGATIVELY IMPACT
      OUR PROJECTED GROWTH AND ABILITY TO GENERATE REVENUES AND PROFITS, WHICH WOULD
      HAVE A NEGATIVE IMPACT ON OUR BUSINESS AND THE VALUE OF YOUR
      INVESTMENT.





We
      rely
      on a combination of patent, patent pending, copyright, trademark and trade
      secret laws, proprietary rights agreements and non-disclosure agreements to
      protect our intellectual properties. We cannot give you any assurance that
      these
      measures will prove to be effective in protecting our intellectual
      properties.





In
      the
      case of patents, we cannot give you any assurance that our existing patents
      will
      not be invalidated, that any patents that we currently or prospectively apply
      for will be granted, or that any of these patents will ultimately provide
      significant commercial benefits. Further, competing companies may circumvent
      any
      patents that we may hold by developing products which closely emulate but do
      not
      infringe our patents. While we currently have and intend to seek patent
      protection for our products in selected foreign countries, those patents may
      not
      receive the same degree of protection as they would in the United States. We
      can
      give you no assurance that we will be able to successfully defend our patents
      and proprietary rights in any action we may file for patent infringement.
      Similarly, we cannot give you any assurance that we will not be required to
      defend against litigation involving the patents or proprietary rights of others,
      or that we will be able to obtain licenses for these rights. Legal and
      accounting costs relating to prosecuting or defending patent infringement
      litigation may be substantial.





The
      WavSTAT(TM) System is protected by eight issued patents, in the United States,
      Canada, Europe and Japan, of which we own and one for which we own the exclusive
      license.





We
      also
      rely on proprietary designs, technologies, processes and know-how not eligible
      for patent protection. We cannot give you any assurance that our competitors
      will not independently develop the same or superior designs, technologies,
      processes and know-how.





While
      we
      have and will continue to enter into proprietary rights agreements with our
      employees and third parties giving us proprietary rights to certain technology
      developed by those employees or parties while engaged by the Company, we can
      give you no assurance that courts of competent jurisdiction will enforce those
      agreements.





THE
      PATENTS WE OWN COMPRISE A LARGE PORTION OF OUR ASSETS, WHICH COULD LIMIT OUR
      FINANCIAL VIABILITY.





The
      WavSTAT(TM) System is protected by eight issued patents, in the United States,
      Canada, Europe and Japan, and an additional patent for which we own an exclusive
      license. These patents comprise a majority of our assets. If our existing
      patents are invalidated or if they fail to provide significant commercial
      benefits, it will severely hurt our financial condition, as a majority of our
      assets would lose their value. Further, since our patents are written down
      over
      the course of their term until they expire, our assets comprised of patents
      will
      continually be written down until they lose value altogether.




-37-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





LEGISLATIVE
      ACTIONS AND POTENTIAL NEW ACCOUNTING PRONOUNCEMENTS ARE LIKELY TO IMPACT OUR
      FUTURE FINANCIAL POSITION AND RESULTS OF OPERATIONS.





There
      have been regulatory changes, including the Sarbanes-Oxley Act of 2002, and
      there may potentially be new accounting pronouncements or additional regulatory
      rulings which will have an impact on our future financial position and results
      of operations. The Sarbanes-Oxley Act of 2002 and other rule changes as well
      as
      proposed legislative initiatives following the Enron bankruptcy have increased
      general and administrative costs as we have incurred increased legal and
      accounting fees to comply with such rule changes. Further, proposed initiatives
      are expected to result in changes in certain accounting rules, including
      legislative and other proposals to account for employee stock options as a
      compensation expense. Stock options we issued in 2005 and 2004 were expensed
      in
      those years under FAS 123. These and other potential changes could materially
      increase the expenses we report under generally accepted accounting principles,
      and adversely affect our operating results.





OUR
      PRODUCTS MAY BE SUBJECT TO RECALL OR PRODUCT LIABILITY CLAIMS.





Our
      WavSTAT(TM) System products may be used in connection with medical procedures
      in
      which it is important that those products function with precision and accuracy.
      If our products do not function as designed, or are designed improperly, we
      may
      be forced by regulatory agencies to withdraw such products from the market.
      In
      addition, if medical personnel or their patients suffer injury as a result
      of
      any failure of our products to function as designed, or an inappropriate design,
      we may be subject to lawsuits seeking significant compensatory and punitive
      damages. Any product recall or lawsuit seeking significant monetary damages
      may
      have a material affect on our business and financial condition.





WE
      HAVE
      NOT PAID ANY CASH DIVIDENDS AND NO CASH DIVIDENDS WILL BE PAID IN THE
      FORESEEABLE FUTURE.





We
      do not
      anticipate paying cash dividends on our common shares in the foreseeable future,
      and we cannot assure an investor that funds will be legally available to pay
      dividends, or that even if the funds are legally available, that the dividends
      will be paid.





THE
      APPLICATION OF THE "PENNY STOCK" RULES COULD ADVERSELY AFFECT THE MARKET PRICE
      OF OUR COMMON SHARES AND INCREASE YOUR TRANSACTION COSTS TO SELL THOSE
      SHARES.





As
      long
      as the trading price of our common shares is below $5 per share, the open-market
      trading of our common shares will be subject to the "penny stock" rules. The
      "penny stock" rules impose additional sales practice requirements on
      broker-dealers who sell securities to persons other than established customers
      and accredited investors (generally those with assets in excess of $1,000,000
      or
      annual income exceeding $200,000 or $300,000 together with their spouse). For
      transactions covered by these rules, the broker-dealer must make a special
      suitability determination for the purchase of securities and have received
      the
      purchaser's written consent to the transaction before the purchase.
      Additionally, for any transaction involving a penny stock, unless exempt, the
      broker-dealer must deliver, before the transaction, a disclosure schedule
      prescribed by the SEC relating to the penny stock market. The broker-dealer
      also
      must disclose the commissions payable to both the broker-dealer and the
      registered representative and current quotations for the securities. Finally,
      monthly statements must be sent disclosing recent price information on the
      limited market in penny stocks. These additional burdens imposed on
      broker-dealers may restrict the ability or decrease the willingness of
      broker-dealers to sell our common shares, and may result in decreased liquidity
      for our common shares and increased transaction costs for sales and purchases
      of
      our common shares as compared to other securities.




-38-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





OUR
      COMMON SHARES ARE THINLY TRADED, SO INVESTORS MAY BE UNABLE TO SELL AT OR NEAR
      ASK PRICES OR AT ALL





Our
      common shares have historically been sporadically or "thinly-traded", meaning
      that the number of persons interested in purchasing our common shares at or
      near
      ask prices at any given time may be relatively small or non-existent. As of
      March 22, 2006, our average trading volume per day for the past three months
      was
      approximately 17,500 shares a day with a high of 96,000 shares traded and a
      low
      of zero shares traded per day. This situation is attributable to a number of
      factors, including the fact that we are a small company which is relatively
      unknown to stock analysts, stock brokers, institutional investors and others
      in
      the investment community that generate or influence sales volume, and that
      even
      if we came to the attention of such persons, they tend to be risk-averse and
      would be reluctant to follow an unproven company such as ours or purchase or
      recommend the purchase of our shares until such time as we became more seasoned
      and viable. As a consequence, there may be periods of several days or more
      when
      trading activity in our shares is minimal or non-existent, as compared to a
      seasoned issuer which has a large and steady volume of trading activity that
      will generally support continuous sales without an adverse effect on share
      price. We cannot give you any assurance that a broader or more active public
      trading market for our common shares will develop or be sustained, or that
      current trading levels will be sustained.





THE
      MARKET PRICE FOR OUR COMMON STOCK IS PARTICULARLY VOLATILE, GIVEN OUR STATUS
      AS
      A RELATIVELY UNKNOWN COMPANY WITH A SMALL AND THINLY-TRADED PUBLIC FLOAT,
      LIMITED OPERATING HISTORY AND LACK OF REVENUES WHICH COULD LEAD TO WIDE
      FLUCTUATIONS IN OUR SHARE PRICE. THE PRICE AT WHICH YOU PURCHASE OUR COMMON
      STOCK MAY NOT BE INDICATIVE OF THE PRICE THAT WILL PREVAIL IN THE TRADING
      MARKET. AN INVESTOR MAY BE UNABLE TO SELL COMMON STOCK AT OR ABOVE THE PURCHASE
      PRICE, WHICH MAY RESULT IN SUBSTANTIAL LOSSES.





The
      market for our common stock is characterized by significant price volatility
      when compared to seasoned issuers, and we expect that our share price will
      continue to be more volatile than a seasoned issuer for the indefinite future.
      In fact, during the ninety-day period ended March 22, 2006, the high and low
      closing prices of a share of our common stock were $1.95 and $0.85,
      respectively. The volatility in our share price is attributable to a number
      of
      factors. First, as noted above, our stock is sporadically and/or thinly traded.
      As a consequence of this lack of liquidity, the trading of relatively small
      quantities of shares by our stockholders may disproportionately influence the
      price of those shares in either direction. The price for our shares could,
      for
      example, decline precipitously in the event that a large number of our shares
      are sold on the market without commensurate demand, as compared to a seasoned
      issuer which could better absorb those sales without adverse impact on its
      share
      price. Secondly, we are a speculative or "risky" investment due to our limited
      operating history and lack of revenues or profits to date and uncertainty of
      future market acceptance for our potential products. As a consequence of this
      enhanced risk, more risk-adverse investors may, under the fear of losing all
      or
      most of their investment in the event of negative news or lack of progress,
      be
      more inclined to sell their shares on the market more quickly and at greater
      discounts than would be the case with the stock of a seasoned issuer. The
      following factors may add to the volatility in the price of our common shares:
      actual or anticipated variations in our quarterly or annual operating results;
      acceptance of our proprietary technology; government regulations, announcements
      of significant acquisitions, strategic partnerships or joint ventures; our
      capital commitments; and additions or departures of our key personnel. Many
      of
      these factors are beyond our control and may decrease the market price of our
      common shares, regardless of our operating performance. We cannot make any
      predictions or projections as to what the prevailing market price for our common
      shares will be at any time, including as to whether our common shares will
      sustain their current market prices, or as to what effect that the sale of
      shares or the availability of common stock for sale at any time will have on
      the
      prevailing market price.




-39-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





Shareholders
      should be aware that, according to SEC Release No. 34-29093, the market for
      penny stocks has suffered in recent years from patterns of fraud and abuse.
      Such
      patterns include (1) control of the market for the security by one or a few
      broker-dealers that are often related to the promoter or issuer; (2)
      manipulation of prices through prearranged matching of purchases and sales
      and
      false and misleading press releases; (3) boiler room practices involving
      high-pressure sales tactics and unrealistic price projections by inexperienced
      sales persons; (4) excessive and undisclosed bid-ask differential and markups
      by
      selling broker-dealers; and (5) the wholesale dumping of the same securities
      by
      promoters and broker-dealers after prices have been manipulated to a desired
      level, along with the resulting inevitable collapse of those prices and with
      consequent investor losses. Our management is aware of the abuses that have
      occurred historically in the penny stock market. Although we do not expect
      to be
      in a position to dictate the behavior of the market or of broker-dealers who
      participate in the market, management will strive within the confines of
      practical limitations to prevent the described patterns from being established
      with respect to our securities. The occurrence of these patterns or practices
      could increase the volatility of our share price.





VOLATILITY
      IN OUR COMMON STOCK PRICE MAY SUBJECT US TO SECURITIES LITIGATION.





The
      market for our common stock is characterized by significant price volatility
      when compared to seasoned issuers, and we expect that our share price will
      continue to be more volatile than a seasoned issuer for the indefinite future.
      In the past, plaintiffs have often initiated securities class action litigation
      against a company following periods of volatility in the market price of its
      securities. We may in the future be the target of similar litigation. Securities
      litigation could result in substantial costs and liabilities and could divert
      management's attention and resources.





OUR
      OFFICERS AND DIRECTORS OWN OR CONTROL APPROXIMATELY 23.8% (INCLUDING ALL OPTIONS
      EXERCISABLE WITHIN 60 DAYS OF MARCH 22, 2006) OF OUR OUTSTANDING COMMON STOCK,
      WHICH MAY LIMIT THE ABILITY OF OTHER STOCKHOLDERS, WHETHER ACTING SINGLY OR
      TOGETHER, TO PROPOSE OR DIRECT THE MANAGEMENT OR OVERALL DIRECTION OF THE
      COMPANY. ADDITIONALLY, THIS CONCENTRATION OF OWNERSHIP COULD DISCOURAGE OR
      PREVENT A POTENTIAL TAKEOVER OF THE COMPANY THAT MIGHT OTHERWISE RESULT IN
      STOCKHOLDERS RECEIVING A PREMIUM OVER THE MARKET PRICE FOR THEIR COMMON
      STOCK.





As
      of
      March 22, 2006, our officers and directors beneficially own or control
      approximately 23.8% (including all options exercisable within sixty days of
      March 22, 2006) of our outstanding common shares. These persons will have the
      ability to control substantially all matters submitted to our stockholders
      for
      approval and to control our management and affairs, including extraordinary
      transactions such as mergers and other changes of corporate control, and going
      private transactions.





A
      LARGE
      NUMBER OF COMMON SHARES ARE ISSUABLE UPON EXERCISE OF OUTSTANDING OPTIONS.
      THE
      EXERCISE OF THESE SECURITIES COULD RESULT IN THE SUBSTANTIAL DILUTION OF THE
      INVESTMENT OF OTHER STOCKHOLDERS IN TERMS OF PERCENTAGE OWNERSHIP IN THE COMPANY
      AS WELL AS THE BOOK VALUE OF THE COMMON SHARES. THE SALE OF A LARGE AMOUNT
      OF
      COMMON SHARES RECEIVED UPON EXERCISE OF THESE OPTIONS ON THE PUBLIC MARKET
      TO
      FINANCE THE EXERCISE PRICE OR TO PAY ASSOCIATED INCOME TAXES, OR THE PERCEPTION
      THAT SUCH SALES COULD OCCUR, COULD SUBSTANTIALLY DEPRESS THE PREVAILING MARKET
      PRICES FOR OUR SHARES.





As
      of
      March 22, 2006, there are outstanding common share purchase options entitling
      the holders to purchase 1,978,500 common shares at a weighted average exercise
      price of $0.28 per share (1,236,833 of these shares are exercisable within
      the
      next 60 days). The exercise price for all of the aforesaid options may be less
      than your cost to acquire our common shares. In the event of the exercise or
      conversion of these convertible securities, you could suffer substantial
      dilution of your investment in terms of your percentage ownership in the company
      as well as the book value of your common shares. In addition, the holders of
      the
      common share purchase options may sell common shares in tandem with their
      exercise of those options to finance that exercise, or may resell the shares
      purchased in order to cover any income tax liabilities that may arise from
      their
      exercise of the options **.**




-40-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





OUR
      ISSUANCE OF ADDITIONAL COMMON SHARES, OR OPTIONS TO PURCHASE THOSE SHARES,
      WOULD
      DILUTE YOUR PROPORTIONATE OWNERSHIP AND VOTING RIGHTS.





We
      are
      entitled under our articles of incorporation to issue up to 125,000,000 shares
      of capital stock, including 100,000,000 shares of common stock and 25,000,000
      undesignated shares (i.e. shares that may be designated as in a senior position
      to the current stock). After taking into consideration our outstanding common
      stock at March 22, 2006, we will be entitled to issue up to 53,526,496
      (100,000,000 authorized less shares outstanding of 46,473,504) additional common
      shares and up to 25,000,000 shares of other series of capital stock. Our board
      of directors may generally issue stock, or options or warrants to purchase
      those
      shares, without further approval by our stockholders based upon such factors
      as
      our board of directors may deem relevant at that time. It is likely that we
      will
      be required to issue a large amount of additional securities to raise capital
      to
      further our development. It is also likely that we will be required to issue
      a
      large amount of additional securities to directors, officers, employees and
      consultants as compensatory grants in connection with their services, both
      in
      the form of stand-alone grants or under our stock plans. We cannot give you
      any
      assurance that we will not issue additional common stock, or options or warrants
      to purchase those shares, under circumstances we may deem appropriate at the
      time.





THE
      ELIMINATION OF MONETARY LIABILITY AGAINST OUR DIRECTORS, OFFICERS AND EMPLOYEES
      UNDER OUR ARTICLES OF INCORPORATION AND THE EXISTENCE OF INDEMNIFICATION RIGHTS
      TO OUR DIRECTORS, OFFICERS, CONSULTANTS AND EMPLOYEES MAY RESULT IN SUBSTANTIAL
      EXPENDITURES BY OUR COMPANY AND MAY DISCOURAGE LAWSUITS AGAINST OUR DIRECTORS,
      OFFICERS, CONSULTANTS AND EMPLOYEES.





Our
      articles of incorporation contains provisions which eliminate the liability
      of
      our directors for monetary damages to the Company and stockholders. Our bylaws
      also require us to indemnify our officers and directors. We may also have
      contractual indemnification obligations under our agreements with our directors,
      officers, consultants and employees. The foregoing indemnification obligations
      could result in our company incurring substantial expenditures to cover the
      cost
      of settlement or damage awards against directors, officers, consultants and
      employees, which we may be unable to recoup. These provisions and resultant
      costs may also discourage the Company from bringing a lawsuit against directors,
      officers, consultants and employees for breaches of their fiduciary duties,
      and
      may similarly discourage the filing of derivative litigation by our stockholders
      against our directors, officers, consultants and employees even though such
      actions, if successful, might otherwise benefit the Company and
      stockholders.





ANTI-TAKEOVER
      PROVISIONS MAY IMPEDE THE ACQUISITION OF OUR COMPANY.





Certain
      provisions of the Minnesota Business Corporation Act and other Minnesota laws
      have anti-takeover effects and may inhibit a non-negotiated merger or other
      business combination. These provisions are intended to encourage any person
      interested in acquiring us to negotiate with, and to obtain the approval of,
      our
      Board of Directors in connection with such a transaction. However, certain
      of
      these provisions may discourage a future acquisition of the Company, including
      an acquisition in which the stockholders might otherwise receive a premium
      for
      their shares. As a result, stockholders who might desire to participate in
      such
      a transaction may not have the opportunity to do so.




-41-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





ITEM
      7. FINANCIAL STATEMENTS.





Audited
      financial statements for the year ended December 31, 2005, the five months
      ended
      December 31, 2004 (Successor Company), and the seven months ended August 1,
      2004
      (Predecessor Company), and financial statements for the period from inception
      (August 2, 2004) to December 31, 2005 are filed as part of this Form
      10-KSB.




-42-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





SpectraScience,
      Inc.


(Development
      Stage Enterprise)





Financial
      Statements





Years
      Ended December 31, 2005 and 2004


PageReport
                  of Independent Registered Public Accounting
                  Firm
              44Balance
                  Sheets as of December 31, 2005 and
                  2004
              45Statements
                  of Operations for the year ended December 31, 2005,
                  the five months ended December 31, 2004, the seven months ended
                  August 1,
                  2004 and from August 2, 2004 (Inception of Successor Company) to
                  December
                  31, 2005
              46Statements
                  of Stockholders’ Equity (Deficit) for the year
                  ended December 31, 2005, the five months ended December 31, 2004,
                  and the
                  seven months ended August 1, 2004
              47Statements
                  of Cash Flows for the year ended December 31, 2005,
                  the five months ended December 31, 2004 the seven months ended
                  August 1,
                  2004 and from August 2, 2004 (Inception of Successor Company) to
                  December
                  31, 2005
              48Notes
                  to Financial Statements
              49






-43-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**




Report
        of Independent Registered Public Accounting
        Firm
 
 
 
 To
        the
        Stockholders and Board of Directors
 SpectraScience,
        Inc.
 
 
 We
        have
        audited the accompanying balance sheets of SpectraScience, Inc. (a development
        stage enterprise) as of December 31, 2005 and 2004, and the related statements
        of operations, stockholders’ equity (deficit) and cash flows for the year ended
        December 31, 2005, for the five months ended December 31, 2004, the seven
        months
        ended August 1, 2004 and from August 2, 2004 (inception of Successor Company)
        to
        December 31, 2005. These financial statements are the responsibility of the
        Company’s management. Our responsibility is to express an opinion on these
        financial statements based on our audits.
 
 We
        conducted our audits in accordance with the standards of the Public Company
        Accounting Oversight Board (United States). Those standards require that
        we plan
        and perform the audit to obtain reasonable assurance about whether the financial
        statements are free of material misstatement. An audit includes examining,
        on a
        test basis, evidence supporting the amounts and disclosures in the financial
        statements. An audit also includes assessing the accounting principles used
        and
        significant estimates made by management, as well as evaluating the overall
        financial statement presentation. We believe that our audits provide a
        reasonable basis for our opinion.
 
 In
        our
        opinion, the financial statements referred to above present fairly, in all
        material respects, the financial position of SpectraScience, Inc. as of December
        31, 2005 and 2004, and its results of operations and cash flows for the year
        ended December 31, 2005, for the period from August 2, 2004 to December 31,
        2004, for the period from January 1, 2004 through August 1, 2004 and from
        August
        2, 2004 (inception of Successor Company) to December 31, 2005, in conformity
        with accounting principles generally accepted in the United States of
        America.
 
 As
        discussed in Note 2 to the financial statements, the Company has incurred
        losses
        and negative cash flows from operating activities from its inception. As
        of
        December 31, 2005, management believes that the Company will require additional
        financing to fund its operations, but cannot assure that such financing will
        be
        available. Such matters raise substantial doubt about the Company’s ability to
        continue as a going concern. Management’s plans concerning these matters are
        also described in Note 2. The financial statements do not include any
        adjustments related to the recoverability and classification of assets, or
        the
        amounts and classification of liabilities, that may result from the outcome
        of
        this uncertainty.
 
 
 /s/
        J.H.
        Cohn LLP
 
 San
        Diego, California
 March
        14,
        2006
  -44-
 **Back
              to Table of Contents**
 **Index
              to Financial
              Statements**


**SpectraScience,
                  Inc.****(Development
                  Stage Enterprise)****Balance
                  Sheets****December
                  31, 2005 and 2004**
  **ASSETS****December
                  31, 2005**
              
              **December
                  31, 2004**CURRENT
                  ASSETSCash
                  and cash equivalents
              
              $
              441,025
              
              $
              1,132,505Inventories
              
              
              140,072
              
              
              149,169Prepaid
                  expenses and other
              
              
              42,310
              
              
              54,400TOTAL
                  CURRENT ASSETS
              
              
              623,407
              
              
              1,336,074FIXED
                  ASSETSOffice
                  furniture
              
              
              1,000
              
              
              1,000Computer
                  equipment
              
              
              4,323
              
              
              4,323Machinery
                  and equipment
              
              
              13,868
              
              
              13,86819,191
              
              
              19,191Less
                  accumulated depreciation
              
              
              (12,794
              )
              
              (3,199
              )TOTAL
                  FIXED ASSETS
              
              
              6,397
              
              
              15,992Patents,
                  net
              
              
              262,626
              
              
              281,949TOTAL
                  ASSETS
              
              $
              892,430
              
              $
              1,634,015**LIABILITIES
                  AND STOCKHOLDERS' EQUITY**CURRENT
                  LIABILITIESAccounts
                  payable
              
              $
              17,498
              
              $
              12,215Accrued
                  compensation and taxes
              
              
              15,205
              
              
              7,684TOTAL
                  LIABILITIES
              
              
              32,703
              
              
              19,899COMMITMENTS
                  AND CONTINGENCIESSTOCKHOLDERS'
                  EQUITYUndesignated
                  capital stock, undesignated par value, 25,000,000shares
                  authorized, none issuedCommon
                  stock, par value of $0.01, 100,000,000 shares authorized37,572,262
                  and 37,550,762 issued and outstanding
              
              
              375,723
              
              
              375,508Additional
                  paid-in capital
              
              
              1,822,123
              
              
              1,743,552Deferred
                  compensation
              
              
              (48,140
              )
              
              (127,253
              )Deficit
                  accumulated during the development stage
              
              
              (1,289,979
              )
              
              (377,691
              )TOTAL
                  STOCKHOLDERS' EQUITY
              
              
              859,727
              
              
              1,614,116TOTAL
                  LIABILITIES AND STOCKHOLDERS' EQUITY
              
              $
              892,430
              
              $
              1,634,015


*See
        Notes to the Financial Statements*






-45-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**


**SpectraScience,
                    Inc.****(Development
                    Stage Enterprise)****Statements
                    of Operations****For
                    the year ended December 31, 2005, for the 5 months ended December
                    31,
                    2004, for the 7 months ended August 1, 2004****and
                    from August 2, 2004 (inception of Successor Company) to December
                    31,
                    2005**
  **Successor
                    Company**
                
                **Successor
                    Company**
                
                **Predecessor
                    Company**
                
                **Successor
                    Company****Year
                    Ended**
                
                **5
                    months ended**
                
                **7
                    months ended**
                
                **August
                    2, 2004 to****December
                    31, 2005**
                
                **December
                    31, 2004**
                
                **August
                    1, 2004**
                
                **December
                    31, 2005**Gross
                    Revenue
                
                $
                —
                
                $
                —
                
                $
                —
                
                $
                —OPERATING
                    EXPENSESResearch
                    and development
                
                
                53,122
                
                
                
                
                
                
                
                
                53,122General
                    and administrative
                
                
                874,957
                
                
                388,886
                
                
                105,960
                
                
                1,263,843928,079
                
                
                388,886
                
                
                105,960
                
                
                1,316,965OPERATING
                    LOSS
                
                
                (928,079
                )
                
                (388,886
                )
                
                (105,960
                )
                
                (1,316,965
                )OTHER
                    INCOME (EXPENSE)Interest
                    expense
                
                
                (180
                )
                
                
                
                
                (24,967
                )
                
                (180
                )Interest
                    income
                
                
                20,935
                
                
                7,006
                
                
                145
                
                
                27,941Gain
                    on disposal of fixed assets
                
                
                4,950
                
                
                4,189
                
                
                
                
                
                9,139Other
                
                
                (9,914
                )
                
                
                
                
                
                
                
                (9,914
                )OTHER
                    INCOME (EXPENSE)
                
                
                15,791
                
                
                11,195
                
                
                (24,822
                )
                
                26,986LOSS
                    BEFORE REORGANIZATION ITEMS
                
                
                (912,288
                )
                
                (377,691
                )
                
                (130,782
                )
                
                (1,289,979
                )Gain
                    on debt forgiveness
                
                
                
                
                
                
                
                
                525,380
                
                
                —NET
                    INCOME (LOSS)
                
                $
                (912,288
                )
                $
                (377,691
                )
                $
                394,598
                
                $
                (1,289,979
                )Basic
                    and diluted net earnings (loss) per share
                
                $
                (0.02
                )
                $
                (0.01
                )
                $
                0.05Weighted
                    average number of commonshares
                    outstanding
                
                
                37,553,366
                
                
                32,313,705
                
                
                7,874,884


*See
        Notes to the Financial Statements*




-46-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**




**SpectraScience,
                  Inc.****(Development
                  Stage Enterprise)****Statements
                  of Stockholders' Equity
                  (Deficit)****For
                  the Year ended December 31, 2005, the 5 months ended December 31,
                  2004 and
                  the 7 months ended August 1, 2004******
  **Deficit****Accumulated**
                
                **Total****Common
                    Stock - old**
                
                **Additional**
                
                **Common
                    Stock - new**
                
                **Additional**
                
                
                
                **During**
                
                **Stockholders'****Paid-In**
                
                
                
                
                
                **Paid-In**
                
                **Deferred**
                
                **Development**
                
                **Equity/****Shares**
                
                **Amount**
                
                **Capital**
                
                **Shares**
                
                **Amount**
                
                **Capital**
                
                **Compensation**
                
                **Stage**
                
                **(Deficit)****Balance,
                    December 31, 2003**
                
                
                7,153,813
                
                $
                1,788,453
                
                $
                54,332,013
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                (57,001,361
                )
                $
                (880,895
                )Issuance
                    of stock options to employees and directors
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                201,514
                
                $
                (201,514
                )Amortization
                    of deferred compensation
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                758
                
                
                
                
                
                758Adjustment
                    for common stock to par value of $0.01
                
                
                
                
                
                (1,716,915
                )
                
                1,716,915Conversion
                    of 3,692,149 old shares into 11,076,447 new shares plus $0.24
                    per
                    share
                
                
                (3,692,149
                )
                
                (36,921
                )
                
                
                
                
                11,076,447
                
                $
                110,764
                
                
                812,273
                
                
                
                
                
                
                
                
                886,116Issuance
                    of common stock for payment of notes payable and interest at
                    $0.10 per
                    share
                
                
                
                
                
                
                
                
                
                
                
                5,650,020
                
                
                56,500
                
                
                508,500
                
                
                
                
                
                
                
                
                565,000Sale
                    of common stock at $0.12 per share
                
                
                
                
                
                
                
                
                
                
                
                4,211,666
                
                
                42,117
                
                
                463,283
                
                
                
                
                
                
                
                
                505,400Settlement
                    of old claim at $0.10 per share
                
                
                
                
                
                
                
                
                
                
                
                600,000
                
                
                6,000
                
                
                54,000
                
                
                
                
                
                
                
                
                60,000Sale
                    of common stock at $0.01 per share
                
                
                
                
                
                
                
                
                
                
                
                12,384,298
                
                
                123,843
                
                
                (73,843
                )
                
                
                
                
                
                
                
                50,000Fresh
                    start adjustment
                
                
                (3,461,664
                )
                
                (34,617
                )
                
                (56,048,928
                )
                
                3,461,664
                
                
                34,617
                
                
                (302,456
                )
                
                
                
                
                56,606,763
                
                
                255,379Net
                    income
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                394,598
                
                
                394,598**Balance,
                    August 2, 2004**
                
                
                
                
                
                
                
                
                
                
                
                37,384,095
                
                
                373,841
                
                
                1,663,271
                
                
                (200,756
                )
                
                
                
                
                1,836,356Sale
                    of common stock at $0.12 per share
                
                
                
                
                
                
                
                
                
                
                
                166,667
                
                
                1,667
                
                
                18,333
                
                
                
                
                
                
                
                
                20,000Issuance
                    of stock options to employees
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                35,825
                
                
                (35,825
                )Compensation
                    from options issued to consultants
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                26,123
                
                
                
                
                
                
                
                
                26,123Amortization
                    of deferred compensation
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                109,328
                
                
                
                
                
                109,328Net
                    loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (377,691
                )
                
                (377,691
                )**Balance,
                    December 31, 2004**
                
                
                
                
                
                
                
                
                
                
                
                37,550,762
                
                
                375,508
                
                
                1,743,552
                
                
                (127,253
                )
                
                (377,691
                )
                
                1,614,116Compensation
                    from options issued to consultants
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                75,561
                
                
                
                
                
                
                
                
                75,561Amortization
                    of deferred compensation
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                79,113
                
                
                
                
                
                79,113Stock
                    options exercised
                
                
                
                
                
                
                
                
                
                
                
                21,500
                
                
                215
                
                
                3,010
                
                
                
                
                
                
                
                
                3,225Net
                    loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (912,288
                )
                
                (912,288
                )**Balance,
                    December 31, 2005**
                
                
                
                
                
                
                
                
                
                
                
                37,572,262
                
                $
                375,723
                
                $
                1,822,123
                
                $
                (48,140
                )
                $
                (1,289,979
                )
                $
                859,727
 *See
          Notes to the Financial Statements*


-47-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





**SpectraScience,
                  Inc.****(Development
                  Stage Enterprise)****Statements
                  of Cash Flows****For
                  the year ended December 31, 2005,****for
                  the 5 months ended December 31, 2004, for the 7 months ended August
                  1,
                  2004****and
                  from August 2, 2004 (inception of Successor Company) to December
                  31,
                  2005**
  **Successor
                    Company Year ended December 31,
                    2005**
              
              **Successor
                    Company 5 months ended December 31,
                    2004**
              
              **Predecessor
                    Company 7 months ended August 1,
                    2004**
              
              **Successor
                  Company August 2, 2004 toDecember 31,
                  2005**Cash
                  flows from operating activities:Net
                  income (loss)
              
              $
              (912,288
              )
              $
              (377,691
              )
              $
              394,598
              
              $
              (1,289,979
              )Adjustments
                  to reconcile net income (loss) to net cash used in operating
                  activities:Depreciation
                  and amortization
              
              
              28,918
              
              
              11,250
              
              
              
              
              
              40,168Gain
                  on discharge of debt
              
              
              
              
              
              
              
              
              (525,380
              )Amortization
                  of deferred compensation
              
              
              79,113
              
              
              109,328
              
              
              758
              
              
              188,441Amortization
                  of options issued to consultants
              
              
              75,561
              
              
              26,123
              
              
              
              
              
              101,684Gain
                  on disposal of fixed assets
              
              
              (4,950
              )
              
              (4,189
              )
              
              
              
              
              (9,139
              )Write-off
                  of obsolete inventory
              
              
              9,097
              
              
              
              
              
              
              
              
              9,097Changes
                  in operating assets and liabilities:Prepaid
                  expenses and other current assets
              
              
              12,090
              
              
              (30,650
              )
              
              (23,750
              )
              
              (18,560
              )Accounts
                  payable
              
              
              5,283
              
              
              (47,487
              )
              
              53,817
              
              
              (42,204
              )Accrued
                  expenses and other liabilities
              
              
              7,521
              
              
              (24,409
              )
              
              26,944
              
              
              (16,888
              )Net
                  cash used in operating activities
              
              
              (699,655
              )
              
              (337,725
              )
              
              (73,013
              )
              
              (1,037,380
              )Cash
                  flows from investing activities - proceeds from the sale of
                  assets
              
              
              4,950
              
              
              8,240
              
              
              
              
              
              13,190Cash
                  flows from financing activities:Proceeds
                  from exchange of common stock
              
              
              
              
              
              
              
              
              886,116Proceeds
                  from issuance of stock in reorganization
              
              
              
              
              
              
              
              
              50,000Proceeds
                  from exercise of employee stock options
              
              
              3,225
              
              
              
              
              
              
              
              
              3,225Proceeds
                  from the issuance of common stock
              
              
              
              
              
              20,000
              
              
              505,400
              
              
              20,000Net
                  cash provided by financing activities
              
              
              3,225
              
              
              20,000
              
              
              1,441,516
              
              
              23,225Net
                  (decrease) increase in cash and cash equivalents
              
              
              (691,480
              )
              
              (309,485
              )
              
              1,368,503
              
              
              (1,000,965
              )Cash
                  and cash equivalents at beginning of period
              
              
              1,132,505
              
              
              1,441,990
              
              
              73,487
              
              
              1,441,990Cash
                  and cash equivalents at end of period
              
              $
              441,025
              
              $
              1,132,505
              
              $
              1,441,990
              
              $
              441,025Supplemental
                  disclosure of non-cash investing and financing activities:Conversion
                  of notes payable and accrued interest to common stock
              
              
              
              
              $
              565,000
              
              
              
              
              $
              565,000Issuance
                  of common stock in settlement of bankruptcy debt
              
              
              
              
              $
              60,000
              
              
              
              
              $
              60,000Fresh
                  start adjustment to fixed assets and patents
              
              
              
              
              $
              255,379
              
              
              
              
              $
              255,379*See
                  Notes to the Financial
                  Statements*




-48-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**




**SpectraScience,
      Inc.**


**(Development
      Stage Enterprise)**





**Notes
      to Financial Statements**





Note
      1 -
      Description of Business





SpectraScience,
      Inc. (the “Company”) filed for bankruptcy protection on September 13, 2002 (U.S.
      Bankruptcy Court, District of Minnesota, Case No. 02-42904). The case was
      converted from liquidation under Chapter 7 to Chapter 11 reorganization in
      early
      2003. The Company’s Plan of Reorganization was confirmed on July 7, 2004 and
      became effective on August 23, 2004. The Company received funding and commenced
      operations effective August 2, 2004. As of August 2, 2004 (for purposes of
      this
      Report, the “Effective Date”) the Company became the “Successor Company” and the
      Company as it existed prior to August 2, 2004 is referred to as the “Predecessor
      Company.” During the bankruptcy, the Company was under the control of a court
      appointed trustee and had no management (all officers and directors had
      resigned), no legal counsel, no outside auditors, no transfer agent, and no
      operations.





The
      Company has adopted “fresh-start reporting,” given the absence of any operating
      activity or other significant activity for almost two years and in accordance
      with the guidelines of “Financial Reporting by Entities in Reorganization under
      the Bankruptcy Code (“SOP 90-7”).





The
      Company was incorporated in the State of Minnesota on May 4, 1983 as GV Medical,
      Inc. In October 1992, GV Medical discontinued its prior business, refocused
      its
      development efforts and changed its name to SpectraScience, Inc. From 1996
      until
      filing for bankruptcy reorganization in 2002, the Company primarily focused
      on
      developing the WavSTAT(TM) Optical Biopsy System (“WavSTAT(TM) System.”). The
      WavSTAT(TM) System is a proprietary, minimally invasive technology that
      optically scans tissue in real-time to distinguish between normal and
      pre-cancerous or cancerous tissue, without the need to remove tissue from the
      body.





Note
      2 -
      Going Concern and Development Stage Enterprise





The
      Company is a development stage enterprise since it has not yet generated any
      revenue from the sale of products and, through December 31, 2005, its efforts
      have been principally devoted to restarting the Company as it emerged from
      bankruptcy. Activities beginning on August 2, 2004 are deemed to be development
      stage operations. Accordingly, Successor Company activities on the accompanying
      financial statements reflect both period to date and inception to date
      development stage activities. As of December 31, 2005, the Company had working
      capital of $590,704 and cash and cash equivalents of $441,025. The Company
      has
      not completed a Regulation S restricted placement of its common stock with
      a
      consortium of European banks. However, if we do not receive these funds in
      a
      timely manner, the Company could be in jeopardy as a going concern. We may
      not
      be able to find alternative capital or raise capital or debt on terms that
      are
      acceptable. The Company believes that if the proceeds from the 2006 private
      placement arrive in the second quarter of 2006, such proceeds will be sufficient
      to allow the Company to sustain operations until it attains profitability and
      positive cash flows from operations. However, we may incur unknown expenses,
      or
      we may not be able to meet our revenue forecast that will require us to seek
      additional capital. In such an event, the Company may not be able to find such
      capital or raise capital or debt on terms that are acceptable.




-49-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





The
      accompanying financial statements have been prepared on a going concern basis,
      which contemplates the realization of assets and the satisfaction of liabilities
      in the normal course of business. The financial statements do not include any
      adjustments relating to the recoverability and classification of assets or
      the
      amounts and classification of liabilities that might be necessary should the
      Company be unable to continue as a going concern.


Note
      3 -
      Summary of Significant Accounting Policies





Risks
      and Uncertainties





The
      Company operates in an industry that is subject to intense competition,
      government regulation and rapid technological change. The Company's operations
      are subject to significant risk and uncertainties including financial,
      operational, technological, regulatory and other risks associated with a
      development stage company, including the potential risk of business
      failure.





Use
      of
      Estimates





The
      Company prepares its financial statements in conformity with accounting
      principles generally accepted in the United States of America, which requires
      management to make estimates and assumptions that affect the amounts reported
      in
      the financial statements and disclosures made in the accompanying notes to
      the
      financials statements. Significant estimates made by management include, among
      others, realization of long-lived assets. Actual results could differ from
      those
      estimates.





Cash
      Equivalents





Highly
      liquid investments with original maturities of three months or less when
      purchased are considered to be cash equivalents.





Stock-Based
      Compensation





At
      December 31, 2005, the Company has one stock-based employee compensation plan
      (the “Option Plan"), which is described more fully in Note 10. Prior to August
      2004, the Company accounted for the Option Plan under the recognition and
      measurement provisions of APB Opinion No. 25, “Accounting for Stock Issued to
      Employees” (“APB 25”), and related interpretations. No stock-based employee
      compensation cost is reflected in net income (loss) for the period ended August
      1, 2004, as all options granted under the Option Plan had an exercise price
      equal to the market value of the underlying common stock on the date of grant.
      Effective August 2, 2004, the Company adopted the fair value recognition
      provisions of Statement of Financial Accounting Standards (“SFAS”), “Accounting
      for Stock-Based Compensation”, (“SFAS 123”) prospectively for all employee and
      consultant awards granted, modified, or settled by the Successor Company. Awards
      under the Company’s Option Plan vest over three years. Therefore, the cost
      related to stock-based employee compensation included in the determination
      of
      net loss for the period ended August 1, 2004 is less than that which would
      have
      been recognized if the fair value-based method had been applied to all awards
      since the original effective date of SFAS 123. The following table illustrates
      the effect on net income (loss) and earnings (loss) per share if the fair
      value-based method had been applied to all outstanding and unvested awards
      in
      each period.




-50-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





In
      accordance with the provisions of SFAS 123 and Emerging Issues Task Force
      (“EITF”) No. 96-18, “Accounting for Equity Instruments That are Issued to Other
      Than Employees for Acquiring or in Conjunction with Selling Goods of Services,”
all other issuances of common stock, stock options or other equity instruments
      to non-employees as the consideration for goods or services received by the
      Company are accounted for based on the fair value of the equity instruments
      issued (unless the fair value of the consideration received can be more reliably
      measured). Any options issued to non-employees are recorded in expense and
      additional paid-in capital in stockholders’ equity (deficiency) over the
      applicable service periods using variable accounting through the vesting date
      based on the fair value of the options at the end of each period.





12
                months ended
              December
                31, 2005
            
            5
                months ended
              December
                31, 2004
            
            7
                months ended
              August
                1, 2004
            
            Successor
                Company
              August
                2, 2004 to December 31, 2005Net
                income (loss):As
                reported
            
            $
            (912,288
            )
            $
            (377,691
            )
            $
            394,598
            
            $
            (1,289,979
            )Employee
                stock-based compensation expense included in reported net income
                (loss)
            
            
            79,113
            
            
            109,328
            
            
            
            
            
            188,441Employee
                stock-based compensation
            
            
            (79,113
            )
            
            (109,328
            )
            
            (146,961
            )
            
            (188,441
            )Pro
                forma netincome
                (loss)
            
            $
            (912,288
            )
            $
            (377,691
            )
            $
            247,637
            
            $
            (1,289,979
            )As
                reported earnings (loss) per share
            
            $
            (0.02
            )
            $
            (0.01
            )
            $
            0.05Pro
                forma earnings (loss) per share
            
            $
            (0.02
            )
            $
            (0.01
            )
            $
            0.03




RECENTLY
        ISSUED ACCOUNTING STANDARDS
 
 In
        December 2004, the Financial Accounting Standards Board issued SFAS No. 123(R), *Share-Based
        Payment,* which
        establishes standards for transactions in which an entity exchanges its equity
        instruments for goods or services. This standard requires an issuer to measure
        the cost of employee services received in exchange for an award of equity
        instruments based on the grant-date fair value of the award. SFAS No. 123(R)
        will be effective for the Company commencing January 1, 2006. We previously
        adopted the fair value recognition provisions of SFAS No. 123, *Accounting
        for Stock-Based Compensation* ,
        on
        August 1, 2004. Accordingly we believe SFAS No. 123(R) will not have a material
        impact on our financial statements.


-51-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





The
      fair
      value of options granted were estimated at the date of grant using a
      Black-Scholes option-pricing model with the following assumptions:




2005
            
            2004Expected
                life
            
            
            5
                years
            
            
            5
                yearsRisk-free
                interest rate
            
            
            4.25
            %
            
            3.89
            %Expected
                volatility
            
            
            219
            %
            
            141
            %Expected
                dividend yield
            
            
            0
            %
            
            0
            %




In
        December 2004, the Financial accounting Standards Board issued SFAS No.123(R),
        Share-Based Payment, which establishes standards for transactions in which
        an
        entity exchanges its equity instruments for goods or services. This standard
        requires an issuer to measure the cost of employee services received in exchange
        for an award of equity instruments based on the grant -date fair value of
        the
        award. SFAS No. 123(R) will be effective for the Company commencing January
        1,
        2006. We previously adopted the fair value recognition provisions of SFAS
        No.
        123, Accounting for Stock-Based Compensation, on August 1, 2004. Accordingly
        we
        believe SFAS No. 123(R) will not have a material impact on our financial
        statements.


Patents





At
      August
      2, 2004, the start of the Successor Company, the Company capitalized $290,000
      for eight patents. The capitalized amount was based on a combination of income
      and market valuation approaches. The income approach used forecasts prepared
      by
      management, with normalizing adjustments for industry benchmarks. These
      forecasts were discounted to present value, and weighted using various
      assumptions based on probability of success from published statistics. The
      market approach used the licensing price of comparable licenses in the market
      to
      arrive at a forecast, with future cash flows discounted to present value.





The
      capitalized patents are being amortized over the shorter of the remaining legal
      life or their estimated economic life. Amortization of patents for the year
      ended December 31, 2005 and the five months ended December 31, 2004 was $19,323
      and $8,051, respectively, and patents are report net of accumulated amortization
      of $27,374 and $8,051 at December 31, 2005 and 2004, respectively. Amortization
      expense in each of the five years subsequent to December 31, 2005 will
      approximate $19,300.





Research
      and Development





Research
      and development costs are expensed as incurred. There may be cases in the future
      where certain research and development costs such as software development costs
      are capitalized. For the year ended December 31, 2005, research and development
      costs were $53,122.





Inventories





Inventories
      are valued at the lower of cost, determined on the first-in, first-out (“FIFO”)
      basis or market value. Costs include direct material, labor and
      overhead.





Fixed
      Assets





On
      August
      2, 2004, fixed assets were adjusted to market value in accordance with the
      requirements of fresh-start reporting. Depreciation is computed using the
      straight-line method over the estimated useful lives of the related assets,
      which range from three to five years. During the period from January 1, 2004
      to
      August 1, 2004, fixed assets were idle and, therefore, no depreciation expense
      was taken. Repairs and maintenance are charged to expense as incurred while
      improvements are capitalized. Upon the sale, retirement or disposal of fixed
      assets, the accounts are relieved of the cost and the related accumulated
      depreciation with any gain or loss recorded to the statements of
      operations.




-52-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





Fair
      Value of Financial Instrument s





The
      carrying amount of the Company's cash and cash equivalents, accounts payable
      and
      accrued liabilities approximate their estimated fair values due to the
      short-term maturities of those financial instruments.





Long-Lived
      Assets





SFAS
      No.144 “Accounting for the Impairment or Disposal of Long-Lived Assets”,
      addresses financial accounting and reporting for the impairment or disposal
      of
      long-lived assets. SFAS 144 requires that long-lived assets be reviewed for
      impairment whenever events or changes in circumstances indicate that their
      carrying amounts may not be recoverable. If the cost basis of a long-lived
      asset
      is greater than the projected future undiscounted net cash flows from such
      asset, an impairment loss is recognized. Impairment losses are calculated as
      the
      difference between the cost basis of an asset and its estimated fair value.
      SFAS
      144 also requires companies to separately report discontinued operations and
      extends that reporting requirement to a component of an entity that either
      has
      been disposed of (by sale, abandonment or in a distribution to owners) or is
      classified as held for sale. Assets to be disposed of are reported at the lower
      of the carrying amount or the estimated fair value less costs to sell. The
      Company adopted SFAS 144 on January 1, 2002. The provisions of this
      pronouncement relating to assets held for disposal generally are required to
      be
      applied prospectively after the adoption date to newly initiated commitments
      to
      sell or dispose of such assets, (as defined), by management. As a result,
      management cannot determine the potential effects that adoption of SFAS 144
      will
      have on the Company's financial statements with respect to future disposal
      decisions, if any. Management believes no impairment exists at December 31,
      2005.





Earnings
      (Loss) Per Share





Under
      SFAS No. 128 "Earnings Per Share", basic earnings (loss) per share is computed
      by dividing net income (loss) available to common stockholders by the weighted
      average number of common shares assumed to be outstanding during the period
      of
      computation. Diluted earnings per share is computed similar to basic earnings
      per share except that the denominator is increased to include the number of
      additional common shares that would have been outstanding if the potential
      common shares had been issued and if the additional common shares were dilutive.
      For all periods presented, basic and diluted loss per share are the same, as
      any
      additional common stock equivalents would be antidilutive. Potentially dilutive
      shares of common stock that have been excluded from the calculation of the
      weighted average number of dilutive common shares for the period ended August
      1,
      2004 were none. For the period ended December 31, 2004 there were options to
      purchase 1,775,000 shares of common stock. For the period ended December 31,
      2005 there were options to purchase 1,978,500 shares of common
      stock.




-53-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





Income
      Taxes





Income
      taxes are provided for the tax effects of transactions reported in the financial
      statements and consist of taxes currently due plus deferred income taxes.
      Deferred income taxes are recognized for temporary differences between the
      financial statement and tax bases of assets and liabilities that will result
      in
      taxable or deductible amounts in the future. Deferred income taxes are also
      recognized for net operating loss carryforwards that are available to offset
      future taxable income and research and development credits. Valuation allowances
      are established when necessary to reduce deferred tax assets to the amount
      expected to be realized.





Reclassifications





Certain
      amounts for 2004 have been reclassified to conform to the 2005
      presentation.





Note
      4 -
      Reorganization and Emergence From Chapter 11





As
      a
      result of the Company’s Plan of Reorganization (the “Plan”), the following
      transactions were performed by the Company:





§
            settled
                and canceled notes, warrants and monetary claims on August 23, 2004
                of
                $952,570 ($331,270 from the former CEO, $535,000 from note and warrant
                holders and $86,300 in accrued interest) by the issuance of 6,250,020
                shares of common stock.





§
            issued
                11,076,447 shares of common stock to stockholders who participated
                in an
                offering of three new shares of common stock in exchange for one
                outstanding share and $0.24 cash generating cash proceeds of
                $886,116.





§
            issued
                12,384,298 shares of common stock to Spectra Acquisition LLC, the
                sponsor
                of the Plan, in satisfaction of a $50,000 investment and as an incentive
                to carrying out the Plan.





§
            settled
                claims to vendors of $66,222 through the payment of cash in the amount
                of
                $5,885. The remaining amount of $60,337 was written
                off.





§
            settled
                claims to employees in the amount of $34,762 through the payment
                of cash
                of $6,273. The remaining amount of $28,489 was written
                off.





§
            wrote
                off liabilities in the amount of $108,699 for accrued liabilities
                and
                trade notes payable that was not to be paid as part of the
                Plan.





On
      the
      Effective Date, the Company established a new Board of Directors consisting
      of
      Jim Hitchin, Mark D. McWilliams, Rand P. Mulford and Chester E. Sievert. Mr.
      Hitchin was elected President, Chief Executive Officer, Secretary and Chief
      Financial Officer. Under the Plan, the Board of Directors shall remain in place
      for three years after the Effective Date at which time the bylaws then in effect
      shall determine elections. Pursuant to the Plan the Company filed an amended
      and
      restated certificate of incorporation authorizing 100,000,000 new shares of
      common stock, par value $0.01 per share and an additional 25,000,000 shares
      without classification for possible future issuance.




The
      Company accounted for the consummation of the Plan as of August 2, 2004,
      coinciding with the funding of the Company. The Company adopted fresh-start
      reporting pursuant to the guidance provided by SOP 90-7. In accordance with
      the
      principles of fresh-start reporting, the Company has adjusted the value of
      its
      assets and liabilities to their fair values as of the Effective Date. The
      reorganization value of the Company was calculated and was based on a variety
      of
      estimates and assumptions about circumstances and events. These estimates and
      assumptions are subject to management’s determination of the timing of events
      pre and post reorganization some of which were beyond the Company’s
      control.




-54-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





Adjustments
      reflected in the fresh-start adjustment balance sheet as of August 2, 2004
      are
      as follows:


**ASSETS****Predecessor
                  Company**
              
              **Reorganization**
              
              
              
              **Exchange
                  of**
              
              
              
              **Fresh
                  Start**
              
              
              
              **Successor
                  Company****August
                  1, 2004**
              
              **Adjustments**
              
              ****
              
              **Common
                  Stock**
              
              ****
              
              **Adjustments**
              
              ****
              
              **August
                  2, 2004**CURRENT
                  ASSETSCash
                  and cash equivalents
              
              $
              517,747
              
              $
              38,127
              
              
              **a/e**
              
              $
              886,116
              
              
              **g**
              
              
              
              
              
              
              
              $
              1,441,990Inventories
              
              
              149,169
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              149,169Prepaid
                  expenses
              
              
              23,750
              
              
              
              
              
              ****
              
              
              ****
              
              
              ****
              
              
              
              
              
              ****
              
              
              23,750TOTAL
                  CURRENT ASSETS
              
              
              690,666
              
              
              38,127
              
              
              ****
              
              
              886,116
              
              
              ****
              
              
              
              
              
              ****
              
              
              1,614,909FIXED
                  ASSETSOffice
                  furniture
              
              
              59,886
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              (54,837
              )
              
              **i**
              
              
              5,049Computer
                  equipment
              
              
              46,643
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (42,320
              )
              
              **i**
              
              
              4,323Machinery
                  and equipment
              
              
              319,155
              
              
              
              
              
              ****
              
              
              ****
              
              
              ****
              
              
              (305,287
              )
              
              **i**
              
              
              13,868425,684
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (402,444
              )
              
              
              
              
              23,240Less
                  accumulated depreciation
              
              
              (367,823
              )
              
              
              
              
              ****
              
              
              ****
              
              
              ****
              
              
              367,823
              
              
              **i**TOTAL
                  FIXED ASSETS
              
              
              57,861
              
              
              
              
              
              ****
              
              
              
              
              
              ****
              
              
              (34,621
              )
              
              ****
              
              
              23,240Patents
              
              
              
              
              
              
              
              
              ****
              
              
              ****
              
              
              ****
              
              
              290,000
              
              
              **j**
              
              
              290,000TOTAL
                  ASSETS
              
              $
              748,527
              
              $
              38,127
              
              
              ****
              
              $
              886,116
              
              
              
              
              $
              255,379
              
              
              ****
              
              $
              1,928,149**LIABILITIES
                  AND STOCKHOLDERS' EQUITY (DEFICIT)**LIABILITIES
                  NOT SUBJECT TO COMPROMISEAccounts
                  payable
              
              $
              59,702
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              59,702Accrued
                  expenses
              
              
              32,091
              
              
              
              
              
              ****
              
              
              ****
              
              
              ****
              
              
              
              
              
              ****
              
              
              32,091TOTAL
                  CURRENT LIABILITIES
              
              
              91,793
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              91,793LIABILITIES
                  SUBJECT TO COMPROMISEAccounts
                  payable
              
              
              66,222
              
              $
              (66,222
              )
              
              **a**Note
                  payable - trade creditors
              
              
              8,514
              
              
              (8,514
              )
              
              **d**Accrued
                  compensation and taxes
              
              
              366,032
              
              
              (366,032
              )
              
              **a/c**Accrued
                  expenses
              
              
              100,185
              
              
              (100,185
              )
              
              **d**Accrued
                  interest
              
              
              86,300
              
              
              (86,300
              )
              
              **b**Convertible
                  notes payable
              
              
              535,000
              
              
              (535,000
              )
              
              **b**
              
              
              ****
              
              
              ****
              
              
              
              
              
              ****TOTAL
                  LIABILITIES SUBJECT TO COMPROMISE
              
              
              1,162,253
              
              
              (1,162,253
              )
              
              ****
              
              
              
              
              
              ****
              
              
              
              
              
              ****STOCKHOLDERS'
                  EQUITY (DEFICIT)Common
                  stock, par value of $0.25, 17,000,000 shares authorized7,153,813
                  issued and outstanding
              
              
              1,788,453
              
              
              
              
              
              
              
              $
              (1,753,836
              )
              
              **g/h**
              
              $
              (34,617
              )Common
                  stock, par value of $0.01, 100,000,000 shares authorized
              
              
              42,117
              
              
              112,500
              
              
              **b/c/e**
              
              
              184,607
              
              
              **g**
              
              
              34,617
              
              
              
              
              
              373,841Additional
                  paid-in capital
              
              
              54,996,811
              
              
              562,500
              
              
              **b/c**
              
              
              2,455,345
              
              
              **g/h**
              
              
              (56,351,385
              )
              
              **k**
              
              
              1,663,271Deferred
                  compensation
              
              
              (200,756
              )
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (200,756
              )Deficit
                  accumulated during the development stage
              
              
              (57,132,144
              )
              
              525,380
              
              
              **f**
              
              
              
              
              
              
              
              
              57,132,144
              
              
              **k******
              
              
              ****
              
              
              ****
              
              
              (525,380
              )
              
              **k**TOTAL
                  STOCKHOLDERS' EQUITY (DEFICIT)
              
              
              (505,519
              )
              
              1,200,380
              
              
              ****
              
              
              886,116
              
              
              ****
              
              
              255,379
              
              
              ****
              
              
              1,836,356TOTAL
                  LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
              
              $
              748,527
              
              $
              38,127
              
              
              
              
              $
              886,116
              
              
              
              
              $
              255,379
              
              
              
              
              $
              1,928,149


-55-
 
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





(a)
      In
      accordance with the Plan, the Company settled claims to vendors and employees
      in
      the amount of $12,158 for claims totaling $100,984. The remaining amount of
      $88,826 was written off.





(b)
      The
      Company owed claims held by Noteholders consisting of $535,000 in original
      principal, accrued interest of $86,300 and warrants to purchase common shares.
      The interest due was accrued and accounted for in the financial records during
      the bankruptcy period. In accordance with the Plan, Noteholders monetary claims
      and purchase warrants were converted to common stock. For every ten cents
      ($0.10) of Eligible Debt owed to the Noteholders, the Company issued one share
      of common stock. A total of 5,650,020 shares were issued to replace the original
      notes, warrants and accrued interest of $30,000. The balance of accrued interest
      totaling $56,300 was written off.





(c)
      In
      accordance with the Plan, the Company issued 600,000 shares of stock at $0.01
      per share for settlement of a $331,270 claim from the former CEO. The remaining
      amount of $271,270 was written off.





(d)
      Certain liabilities of the Predecessor Company were written off totaling
      $108,699.





(e)
      In
      accordance with the Plan, 5,000,000 shares were issued to Spectra Acquisition,
      LLC, the sponsor of the Plan in satisfaction of a $50,000 investment as an
      incentive to carrying out the Plan.





(f)
      The
      Company recorded a gain on the forgiveness of debt for liabilities written
      off
      (see a, b, c, d and e.)





(g)
      In
      accordance with the Plan, the Company issued three new shares of common stock
      in
      exchange for one outstanding old share and $0.24 cash. A total of 11,076,447
      shares of common stock were issued. Additionally, 7,384,298 shares of common
      stock were issued to Spectra Acquisition, LLC as an incentive to convert the
      common stock and execute the Plan.





(h)
      Adjustment of common stock for old shares still trading to the new par value
      of
      $0.01 from the original par value of $0.25.





(i)
      Adjustment of fixed assets to the fair market value.





(j)
      Adjustment to record the value of 8 patents held. Management determined the
      value of the patents was $290,000 (see Note 3).





(k)
      Adjustment of accumulated deficit from the Predecessor Company to
      zero.




-56-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





Note
      5 -
      Inventories





At
      December 31, 2005 and 2004, inventories consisted of the following:




2005
            
            2004Raw
                materials
            
            $
            79,155
            
            $
            98,346Work
                in process
            
            
            0
            
            
            4,832Finished
                goods
            
            
            60,917
            
            
            45,991$
            140,072
            
            $
            149,169





Note
      6 -
      Retirement Plan





The
      Predecessor Company had a 401(k) profit sharing and savings plan covering
      substantially all employees. The plan allowed employees to defer up to 15%
      of
      their annual earnings. The Company matched 50% of the first 6% of the employee
      contributions. No contributions were made during the bankruptcy and the plan
      expired upon the confirmation of the Plan. The Successor Company has no employee
      retirement benefit plans.




Note
      7 -
      Notes Payable





The
      Company had no notes payable in 2005. The Company had notes payable of $535,000
      outstanding at August 1, 2004. The notes were as a result of a private placement
      offering during July 2002 of the Company’s convertible promissory notes and had
      detachable warrants to purchase Company common stock at $0.25 per share. The
      promissory notes were due on December 31, 2002 with interest at 8% per annum.
      In
      accordance with the Plan, all notes, purchase warrants and accrued interest
      capped at $30,000 were converted to common stock. For every ten cents ($0.10)
      of
      notes payable and accrued interest owed to the noteholders, the Company issued
      one share of common stock. A total of 5,650,020 shares of common stock were
      issued to replace the original notes, warrants, and accrued interest. In
      conjunction with the issuance of the notes and warrants in July 2002, a
      beneficial conversion feature of $535,000 was established and amortized to
      interest expense over the term of the notes payable.




-57-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





Note
      8 -
      Income Taxes





The
      significant components of deferred tax assets as of December 31, 2005 and 2004
      are shown below. A valuation allowance has been established to offset the
      deferred tax assets, as realization of such assets is uncertain.





Year
                Ended
              December
                31,
              2005
            
            Five
                months
              Ended
              December
                31,
              2004Deferred
                tax assets:Net
                operating losscarryforward
            
            $
            13,591,000
            
            $
            14,695,000Research
                and development credits
            
            
            519,000
            
            
            644,000Inventory
                reserve
            
            
            177,000
            
            
            136,000Accrued
                liabilities
            
            
            5,000
            
            
            3,000Deferred
                compensation
            
            
            120,000
            
            
            54,000Total
                deferred tax assets
            
            
            14,412,000
            
            
            15,532,000Valuation
                allowance
            
            
            (14,270,000
            )
            
            (15,416,000
            )Net
                deferred tax assets
            
            
            142,000
            
            
            116,000Deferred
                tax liability:Patents
            
            
            (142,000
            )
            
            (116,000
            )Net
                deferred taxes
            
            $
            —
            
            $
            —





The
      following reconciles the tax provision with the expected provision obtained
      by
      applying statutory rates to pretax income:





Year
                Ended December 31,
              2005
            
            Five
                months
              Ended
              December
                31,
              2004
            
            Seven
                months
              Ended
              August
                1,
              2004Expected
                tax at Federalstatutory
                rates
            
            $
            (310,000
            )
            $
            (131,000
            )
            $
            134,000Change
                in valuation allowance
            
            
            (1,146,000
            )
            
            (1,596,000
            )
            
            (155,000
            )Expiration
                of net operating loss carryforwards
            
            
            1,387,000
            
            
            1,560,000Expiration
                of credits
            
            
            126,000State
                taxes, net
            
            
            (53,000
            )
            
            65,000
            
            
            25,000Tax
                credits
            
            
            (3,000
            )
            
            
            
            
            (4,000
            )Other,
                net
            
            
            (1,000
            )Fresh
                start accounting
            
            
            —
            
            
            102,000Tax
                provision
            
            $
            —
            
            $
            —
            
            $
            —




At
        December 31, 2005, the Company had Federal net operating loss carryforwards
        of
        approximately $32,600,000 that expire in 2006 through 2025. In addition,
        the
        Company had research and development tax credits of approximately $517,000
        that
        expire in 2007 through 2020. As a result of previous stock transactions,
        the
        Company's ability to utilize its net operating loss carryforwards to offset
        future taxable income and utilize future research and development tax credits
        is
        subject to certain limitations under Section 382 of the Internal Revenue
        Code
        due to changes in equity ownership of the Company. The Company expects
        significant limitations of its net operating loss carryforwards and research
        and
        development tax credits due to the application of Internal Revenue Code Section
        382.




-58-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





Note
      9 -
      Lease Commitments





The
      Company leases its 2,540 square foot facility from an independent third party
      at
      approximately $2,540 per month which expires on February 28, 2007. Total future
      commitment under this lease as of December 31, 2005 are approximately $32,000
      and $4,000 for 2006 and 2007, respectively. For the years ended December 31,
      2005 and 2004, rent expense totaled $34,061 and $16,564,
      respectively.




Note
      10 -
      Stock-Based Compensation Plan s





The
      2001
      stock option plan (the “Option Plan”) was amended in 2004. The Option Plan
      provides for the grant of incentive stock options (ISOs") to our full-time
      employees (who may also be Directors) and nonqualified stock options ("NSOs")
      to
      non-employee directors, consultants, customers, vendors or providers of
      significant services and expires on January 30, 2011. The exercise price of
      any
      ISO may not be less than the fair market value of the common stock on the date
      of grant and the term shall not exceed ten years. The amount reserved under
      the
      Plan shall equal 15% of the outstanding shares of the Company totaling 5,635,839
      at December 31, 2005. At December 31, 2005, the Company had granted 1,978,500
      options under the Plan (1,236,833 of which were immediately exercisable), with
      3,632,614 available for future issuance.





We
      registered the shares in our Option Plan on September 9, 2005 with the SEC
      with
      a registration statement on Form S-8.





The
      following table summarizes information about options outstanding at December
      31,
      2005:





Options
                Outstanding
            
            Options
                ExercisableExercise
                Price
            
            Number
                of Options
              Outstanding
            
            Weighted
                Average
              Exercise
                Price
            
            Weighted
                Average
              Remaining
              Contractual
                Life
            
            Number
                of Options Exercisable
            
            Weighted
                Average Exercise Price$0.15
            
            
            1,478,500
            
            $
            0.15
            
            
            8.57
            
            
            978,500
            
            $
            0.15$0.40
            
            
            275,000
            
            $
            0.40
            
            
            8.79
            
            
            183,333
            
            $
            0.40$0.90
            
            
            25,000
            
            $
            0.90
            
            
            9.28
            
            
            8,333
            
            $
            0.90$0.95
            
            
            200,000
            
            $
            0.95
            
            
            9.98
            
            
            66,667
            
            $
            0.95Totals
            
            
            1,978,500
            
            $
            0.28
            
            
            8.76
            
            
            1,236,833
            
            $
            0.24








-59-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**




The
      Predecessor Company had two stock option plans, the 1991 Stock Plan and 2001
      Stock Plan (“Plans”), under which selected employees and non-employees could be
      granted incentive and non-qualified options to purchase common stock of the
      Company. The 1991 Stock Plan has terminated and no further awards can be issued
      under that plan. The options granted were exercisable over a period of no longer
      than ten years and were granted at the higher of the fair market value of the
      Company's common stock or a ten-day rolling average of the fair market value
      of
      the common stock as of the date of grant. The Company had reserved 1,807,712
      shares for issuance under the Plans.





The
      following table summarizes the stock option activity for the Predecessor and
      Successor plans:





Options
                Available
              For
                Grant
            
            Plan
                Options Outstanding
            
            Non-Plan
                Options Outstanding
            
            Weighted
                Average Exercise Price ShareBalance,
                December 31, 2003
            
            
            750,000
            
            
            1,057,712
            
            
            343,000
            
            $
            4.92Options
                authorized
            
            
            4,882,614Options
                granted
            
            
            (1,500,000
            )
            
            1,500,000
            
            
            
            
            $
            0.15Options
                exercisedOptions
                cancelled under Plan
            
            
            
            
            
            (1,057,712
            )
            
            (343,000
            )
            $
            (4.92
            )Balance,
                August 2, 2004
            
            
            4,132,614
            
            
            1,500,000
            
            
            —
            
            $
            0.15Options
                granted
            
            
            (275,000
            )
            
            275,000
            
            
            
            
            $
            0.40Options
                exercisedBalance,
                December 31, 2004
            
            
            3,857,614
            
            
            1,775,000
            
            
            —
            
            $
            0.19Options
                granted
            
            
            (225,000
            )
            
            225,000
            
            
            —
            
            $
            0.94Options
                exercised
            
            
            —
            
            
            (21,500
            )
            
            —
            
            $
            0.15Balance,
                December 31, 2005
            
            
            3,632,614
            
            
            1,978,500
            
            
            —
            
            $
            0.28





Note
      11 -
      Undesignated Capital Stock





The
      Company has authorized 25,000,000 of undesignated shares of capital stock with
      undesignated par value. The undesignated stock may be issued in one or more
      series as determined from time to time by the Board of Directors. Any series
      authorized for issuance by the Board of Directors may be senior to the common
      stock with respect to any distribution if so designated by the Board of
      Directors upon issuance of the shares of that series. The Board of Directors
      are
      granted the express authority to fix by resolution any other designations,
      powers, preferences, rights (including voting rights), qualifications,
      limitations or restrictions with respect to any particular series created from
      the undesignated stock prior to issuance thereof.





Note
      12 -
      Concentrations of Credit Risk





Financials
      instruments which potentially subject the Company to concentrations of credit
      risk consist primarily of cash and cash equivalents. The Company maintains
      its
      cash and cash equivalents with high-credit quality financial institutions.
      At
      times, such amounts may exceed insured limits. At December 31, 2005, the Company
      had cash balances of approximately $351,000 in excess of insured limits. The
      Company has not experienced any losses in such accounts and believes it is
      not
      exposed to any significant credit risk on its cash equivalent
      accounts.




-60-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





Note
      13 -
      Related Party Transactions





In
      July
      2004, the Company issued 12,384,298 shares to Spectra Acquisition LLC, the
      sponsor of the Plan, in satisfaction of a $50,000 investment and as an incentive
      to carrying out the Plan. Spectra Acquisition LLC (“SA LLC”) is 51% owned by Mr.
      Hitchin the president/chief executive officer and director of the Company and
      48% by an unrelated third party, and 1% by Spectra Acquisition Inc. (“SAI”). SAI
      is owned Mr. Hitchin and the third party. SA LLC distributed the shares based
      on
      an agreed formula whereby Mr. Hitchin would receive 7,000,000 shares and the
      balance would be split between him and the third party based on their respective
      beneficial interests in SA LLC.





Note
      14 -
      License Agreement





The
      Company is the exclusive licensee through the Massachusetts General Hospital
      of
      US Patent number 5,843,000 entitled, “Optical Biopsy Forceps and Method of
      Diagnosing Tissue” and a pending international patent application. This license
      agreement requires a royalty be paid on sales of the patent on products using
      claims described within the patent under the license. To date no revenues have
      been generated from sales of products using this patent.





Note
      15 -
      Pending Sale of Common Stock





In
      October 2005, the Company accepted a proposal from a consortium of European
      banks to sell them approximately 9,000,000 shares of the Company’s common stock
      discounted 33% from the listed quoted price on the acceptance date
      (approximately $6,000,000). On October 20, 2005, shares of the Company’s common
      stock were transferred to an escrow account.




ITEM
      8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
      AND FINANCIAL DISCLOSURE.





During
      2005, there were no changes or disagreements with our current auditors, J.H.
      Cohn LLP.





ITEM
      8A. CONTROLS AND PROCEDURES.





Evaluation
      of Disclosure Controls and Procedures





Under
      the
      supervision of and with the participation of our management, including our
      Chief
      Executive Officer, we evaluated the effectiveness of the design and operation
      of
      our disclosure controls and procedures (as defined in Rule 13a-14(c) under
      the
      Exchange Act) as of the end of the period covered by this report (the
“Evaluation Date”). Based on that evaluation, the Chief Executive Officer
      concluded that our disclosure controls and procedures were effective in timely
      alerting the Company’s management to material information relating to the
      Company and required to be included in its periodic SEC filings.




-61-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





During
      2005, we contracted with a consulting firm to assist us on accounting issues.
      Additionally, we have also changed our procedures for preparing financial
      statements to include a review of all aspects of our financial statements and
      footnotes. Other than those noted, there were no significant changes in the
      Company's internal controls over financial reporting or in other factors during
      the year ended December 31, 2005 which could significantly affect internal
      controls over financial reporting. As a result our independent registered public
      accounting firm found no material weaknesses in our disclosure controls and
      procedures.





Changes
      in Internal Controls





There
      were no significant changes in internal controls during the period covered
      by
      this report.





A
      control
      system, no matter how well-designed and operated, cannot provide absolute
      assurance that the objectives of the control system are met, and no evaluation
      of internal controls can provide absolute assurance that all control issues
      and
      instances of fraud, if any, within a company have been detected.





ITEM
      8B. OTHER INFORMATION.





Not
      Applicable.




**PART
      III**





ITEM
      9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
      COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT .





SpectraScience
      Directors and Executive Officers





**Jim
      Hitchin, Chairman, President, Chief Financial Officer, Secretary and CEO,
      Director since 2004, Age 63,** joined
      SpectraScience in January 2004 as part of the acquisition team. Previously
      he
      was the founder, CEO and Chairman of Infrasonics, Inc., a medical device company
      in the respiratory care field. The company was the first in its market to have
      ISO9001 and the CE Mark for fourteen 510(k) and two PMA products. Growth was
      at
      a compound rate of 62% during its fifteen-year life before being sold to a
      competitor. In previous companies, he was COO of a public energy company and
      the
      VP, General Manager of a public oceanographic engineering firm. Mr. Hitchin
      has
      extensive experience in all phases of manufacturing and company operations,
      in
      particular, sales and marketing of medical devices. He graduated from San Diego
      State University with a degree in Physics.





**Mark
      D. McWilliams, Director since 2004, Age 49,** Most
      recently served as Director of Cell Imaging and Analysis at Beckman Coulter
      after the recent sale of Q3DM to Beckman in December 2003. He was President
      and
      Chief Executive Officer and Director of Q3DM, a life-sciences startup that
      raised several angel and venture capital funding rounds. Previously, he was
      founder and COO of Medication Delivery Devices (MDD), an alternate care infusion
      systems company that was acquired by Baxter Healthcare in 1996. Mr. McWilliams
      served as a VP of Research and Development at Baxter Healthcare for three years
      following the sale of MDD. Prior to MDD, he served as Product Development
      Manager at the founding of Block Medical where he was responsible for bringing
      the company’s first two FDA approved products rapidly to market. Block was sold
      to Hillenbrand  Industries
      in 1991. He previously worked for Hughes Aircraft, Vacuum General and Martin
      Marietta. He earned his MSME from the Massachusetts Institute of Technology,
      his
      BSME from Northeastern University and holds eight utility patents.




-62-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





**Rand
      P. Mulford, Director since 2004, Age 62,** Most
      recently, Mr. Mulford served as E.V.P. for Strategy with Forest Capital, with
      a
      majority of his time allocated to assisting one of its subsidiaries, Telos
      Pharmaceuticals, in corporate development and financing. For the previous two
      years, He was part of the senior management team of a small investment banking
      firm that specialized in funding early stage companies and technology-based
      spinouts using private placements. He has worked directly with four portfolio
      companies. Mr. Mulford was asked to identify critical issues and develop
      business strategy, serve on three of the Boards of Directors, assume a direct
      managerial role in two of the companies, and negotiate the successful sale
      of
      one of the companies. His corporate experience includes: Group V.P. of planning
      and control for a petrochemical company; head of corporate planning at Merck;
      C.F.O. of a human tissue company; C.O.O. of a drug discovery company and
      president of its subsidiary, a research chemical company; C.O.O. of a
      diagnostics company; Chairman of the Board of a medical device company; and
      head
      of the corporate development at a bio-pharmaceutical company. Mr. Mulford
      started his business career with the consulting firm of McKinsey & Co. in
      the Chicago office. During an eight-year period, he served about twenty clients
      working on a variety of issues primarily related to strategy and organization.
      Mr. Mulford obtained his bachelors degree in engineering with honors from
      Princeton University in 1965. For the next five years he served as a naval
      officer in the nuclear submarine program. Subsequently, he earned a M.B.A.
      with
      high distinction at Harvard Business School.





**Chester
      E. Sievert, Jr., Director since 2004, Age 54,** is
      currently President of Advanced Photodynamic Technologies. He joined
      SpectraScience as a consultant in June 1996 and has held various executive
      positions since November 1996. Mr. Sievert served as Chairman of the Board
      beginning in June 1999. He served as President from March 1998, and Chief
      Executive Officer from January 1999 until December 2001. He then became
      Executive Vice President of Technology and Chairman of the Board. Prior to
      joining SpectraScience, Mr. Sievert was a founder and President at two medical
      product companies; ReTech, Inc. from 1980 to 1986; and FlexMedics Corporation
      from 1986 to 1995. Both Companies were sold respectively to American Endoscopy,
      Inc. and Phillips Plastics Corporation. As a former Senior Research Health
      Scientist on staff at the University of Minnesota Medical School and the
      Veterans Administration Medical Center, Mr. Sievert has published more than
      50
      medical journal articles in the fields of gastroenterology, endoscopy and fiber
      optics. He has also been awarded eight United States and International patents.
      Mr. Sievert has a Bachelor of Science Degree in Comparative Physiology from
      the
      University of Minnesota.





Section
      16(a) Beneficial Ownership Reporting Compliance





Section
      16(a) of the Securities Exchange Act of 1934, as amended, requires our
      directors, executive officers and persons who are beneficial owners of more
      than
      10% of our common stock to file initial reports of ownership and reports of
      changes in ownership of our common stock and any other equity securities of
      SpectraScience with the Securities and Exchange Commission, and to furnish
      us
      with copies of all Section 16(a) reports they file. To the best of our
      knowledge, based upon a review of the copies of such reports furnished to us,
      no
      other reports were required during the year ended December 31, 2005 and all
      Section 16(a) filing requirements applicable to our Officers, Directors, and
      10%
      stockholders were satisfied.




-63-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





ITEM
      10. EXECUTIVE COMPENSATION.





Cash
      Compensation





Compensation
      awarded, paid to, or earned in the years ended December 31, 2005, 2004 and
      2003
      by the person serving as the Company’s Chief Executive Officer (the “Named
      Executive Officer”) as of December 31, 2005 is shown in the following table. No
      other executive officer serving as of December 31, 2005 had salary or bonus
      compensation exceeding $100,000.





Name
                and Principal Position
            
            Year
            
            Salary
            
            Bonus
            
            Other
                Annual Compen-sation
            
            Long
                Term Compensation Securities Underlying Option/s SARs
            
            All
                Other Compen-sationJIM
                HITCHIN
            
            
            2005
            
            $
            48,000
            
            $
            0
            
            $
            0
            
            
            N/A
            
            
            NonePresident,
                Chief Executive Officer,
            
            
            2004
            
            $
            19,385
            
            $
            0
            
            $
            0
            
            
            N/A
            
            
            NoneChief
              Financial Officer and Corporate
              Secretary
            
            
            2003
            
            
            0
            
            $
            0
            
            $
            0
            
            
            N/A
            
            
            None







*
            Mr.
                Hitchin became involved in researching the Company in January 2004
                with
                the interest of developing a plan of reorganization. He did not become
                an
                officer and director until August 2004.The
                Company had no directors, officers or employees from September 13,
                2002
                until August 2, 2004.






-64-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**




Option
      and Stock Appreciation Rights





There
      were no grants of stock options or stock appreciation rights made to the named
      executive officer during the years ended December 31, 2005 and
      2004.





Aggregated
      Option/SAR Exercises in Last Fiscal Year and Fiscal Year End Option
      Values





Since
      the
      emergence of the Company from bankruptcy, no named executive officer has
      received a stock option.





Remuneration
      of Members of the Board of Directors





Directors’
      Fees .
      The
      Company does not pay directors for Board of Directors’ meetings or committee
      meetings attended, but reimburses each such director for reasonable travel
      and
      out-of-pocket expenses for attendance at these meetings. Should a director
      be
      required to expend an extraordinary amount of time performing a Company task,
      he/she would be compensated at a rate of $100/hour. No such payments were made
      in 2005 or 2004.





Pursuant
      to the SpectraScience, Inc. Amended 2001 Stock Option Plan, non-employee
      directors McWilliams, Mulford and Sievert were granted non-qualified stock
      options to purchase 400,000, 400,000 and 300,000 shares of common stock,
      respectively, on July 26, 2004 at $0.15 per share. The exercise prices of the
      options was based on the prevailing market price (defined as the closing price)
      of the common stock on the date of grant.





The
      options granted to employee and non-employee directors under the Amended 2001
      Stock Option Plan expire ten years from the date of grant (subject to earlier
      termination in the event of death), are not transferable (except by will or
      the
      laws of descent and distribution), and become exercisable in three equal annual
      installments commencing on the date of grant.





ITEM
      11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
      MANAGEMENT AND RELATED STOCKHOLDER MATTERS.





Recent
      Sales of Unregistered Securities





The
      Company issued common stock during the third quarter of 2005 without
      registration under the Securities Act in connection with a restricted private
      placement of securities under Regulation S as described in the following table.
      Funds from this placement have not been received as of the date we filed this
      report.




-65-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





2006
      Possible Sale of Common Stock (Note: These securities have been delivered but
      payment has not been received as of the filing of this report)





No.
                of Shares
            8,901,242Type
                of purchasers
            Accredited
                Investors(1)Price/Share
            $0.67Aggregate
                Cash Proceeds
            $5,963,832Exemption
                from Registration
            Regulation
                S of the Securities Act





The
      gross
      proceeds of this offering is expected to be $5,963,832, but the funds have
      not
      been received as of the date we filed this report. The Company has agreed to
      register these shares with the SEC in 2006, however there is an agreement that
      no shares will be sold for at least one year.





**2004
      Sale of Common Stock**





**Private
                Placement**
            **Chapter
                11 Plan**No.
                of Shares
            4,378,333
            29,710,766(2)Type
                of purchasers
            Accredited
                Investors(1)
            Participants
                in Rights Offering, Claimants, Plan Sponsor(2)Price/Share
            $0.12
            See
                Note(2),
                belowAggregate
                Cash Proceeds
            $525,400
            $936,116Exemption
                from Registration
            Sections
                4(2) and 4(6) of the Securities Act and Regulation D
            §1145
                of the Bankruptcy Act





No
      agents
      or underwriters participated in the 2004 sale and no commission or other
      compensation was paid for placement of the securities.





1.
            As
                defined in Regulation D under the Securities
                Act.


2.
            In
                the rights offering a holder of common stock was required to exchange
                one
                share and $0.24 for three new shares. The trading price of the common
                stock during the rights offering ranged from approximately $0.12
                to $0.45.
                11,076,447 shares were issued in the rights offering. Creditors consisted
                of the former CEO (600,000 shares) and Noteholders and warrant holders
                (5,650,020 shares). The price paid by them was extinguishment of
                all
                claims (roughly $0.10 per share). During 2004, the Company issued
                12,384,298 shares to Spectra Acquisition LLC, the sponsor of the
                Plan, in
                satisfaction of a $50,000 investment and as an incentive to carrying
                out
                the Plan. Spectra Acquisition LLC is 51% owned by Mr. Hitchin, the
                president/chief executive officer and a director of the Company,
                48% by an
                unrelated third party and 1% by Spectra Acquisition Inc. (SAI). SAI
                is
                owned by Mr. Hitchin and the third party. SA LLC distributed the
                shares
                based on an agreed formula whereby Mr. Hitchin would receive 7,000,000
                shares and the balance would be split between him and the third party
                based on their beneficial interests in SA
                LLC.






-66-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**


Summary
      of Securities Authorized for Issuance Under Equity Compensation
      Plans





The
      following table sets forth December 31, 2005 information on our equity
      compensation plans in effect as of that date:





(a)
            
            (b)
            
            (c)Plan
                category
            
            Number
                of securities to be issued upon exercise of outstanding options,
                warrants
                and rights (1)
            
            Weighted-average
                exercise price of outstanding options, warrants and rights
            
            Number
                of securities remaining available for future issuance under equity
                compensation plans (excluding securities reflected in column
                (a))Equity
                compensation plans approved by security holders
            
            
            1,978,500
            
            $
            0.28
            
            
            3,632,614Equity
                compensation plans not approved by security holders
            
            
            0
            
            
            0
            
            
            N/ATotals
            
            
            1,978,500
            
            $
            0.28
            
            
            3,632,614





(1)
            Net
                of equity instruments forfeited, exercised or
                expired.





2001
      Amended Stock Option Plan





Our
      2001
      Amended Stock Option Plan (the "Option Plan") provides for the grant of
      incentive stock options (ISOs") to our employees (who may also be directors)
      and
      nonqualified stock options ("NSOs") to non-employee directors, consultants,
      customers, vendors or providers of significant services. The Option plan expires
      on January 30, 2011. The exercise price of any ISO may not be less than the
      fair
      market value of the common stock on the date of grant and the term shall not
      exceed ten years. The amount reserved under the Option Plan equals 15% of the
      outstanding shares of the Company totaling 5,635,839 at December 31, 2004.
      At
      December 31, 2005, we had granted 1,978,500 options under the Plan, with
      3,632,614 available for future issuance.





The
      Company’s Option Plan provides that the number of shares of common stock
      available for issuance under the plan shall always equal 15% of the number
      of
      shares of common stock of the Company issued and outstanding.




-67-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**




Principal
      and Management Shareholders





The
      following tables set forth certain information regarding the beneficial
      ownership of SpectraScience common stock as of March 22, 2006, by: (a) each
      director of SpectraScience (as of March 22, 2006; (b) each named executive
      officer of SpectraScience; (c) each person or entity known by us to own
      beneficially more than five percent of the Common Stock; and (d) all the
      directors and executive officers of SpectraScience (as of March 22, 2006) as
      a
      group.








Name
                and Address
              11568-11
                Sorrento Valley Rd.,
              San
                Diego, CA 92014 for all parties
            
            Amount
                of Beneficial Ownership
            
            Percent
              OwnershipJim
                Hitchin
            
            
            9,192,149
            
            
            19.8
            %Mark
                D. McWilliams
            
            
            474,999(1
            )
            
            1.0
            %Rand
                P, Mulford
            
            
            606,666(2
            )
            
            1.3
            %Chester
                E. Sievert
            
            
            800,000(3
            )
            
            1.7
            %All
                Officers & Directors
            
            
            11,073,814
            
            
            23.8
            %





1.
            Includes
                266,666 shares which may be acquired upon exercise of warrants/options
                which are currently exercisable or which become exercisable within
                60 days
                following the date of this report.


2.
            Includes
                266,666 shares which may be acquired upon exercise of warrants/options
                which are currently exercisable or which become exercisable within
                60 days
                following the date of this report.


3.
            Includes
                200,000 shares which may be acquired upon exercise of warrants/options
                which are currently exercisable or which become exercisable within
                60 days
                following the date of this report.





ITEM
      12. CERTAIN RELATIONSHIPS AND RELATED
      TRANSACTIONS.





During
      2004, the Company issued 12,384,298 shares to Spectra Acquisition LLC, the
      sponsor of the Plan, in satisfaction of a $50,000 investment and as an incentive
      to carrying out the Plan. Spectra Acquisition LLC (SA LLC) is 51% owned by
      Mr.
      Hitchin, the president/chief executive officer and a director of the Company
      and
      48% by an unrelated third party, and 1% by Spectra Acquisition Inc. (SAI).
      SAI
      is owned by Mr. Hitchin and the third party. SA LLC distributed the shares
      based
      on an agreed formula whereby Mr. Hitchin would receive 7,000,000 shares and
      the
      balance was split between him and the third party based on their respective
      beneficial interests in SA LLC.




-68-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





ITEM
      13. EXHIBITS





The
      following documents are filed as part of this report on Form
      10-KSB:




Exhibits
      Required by Item 601 of Regulation S-B





Exhibit
                No.
            Description3.1
            Amended
                and Restated Articles of Incorporation(1)10.27
            Amended
                SpectraScience Inc, 2001 Stock Plan(1)10.28
            Form
                of Directors’ Option Agreement(2)14
            Code
                of Ethics23
            Consent
                of Independent Registered Public Accounting Firm31
            Certification
                of Chief Executive Officer and Chief Financial Officer pursuant to
                Section
                302 of the Sarbanes-Oxley Act of 200232
            Certification
                of Chief Executive Officer and Chief Financial Officer pursuant to
                Section
                906 of the Sarbanes-Oxley Act of
                2002







(1)
            Incorporated
                by reference to the Company’s Report on Form 8-K, filed on August 6,
                2004.


(2)
            Incorporated
                by reference to the Company’s Report on form 10-KSB for the fiscal year
                ended December 31, 2004, filed on July 5,
                2005.





ITEM
      14. PRINCIPAL ACCOUNTANT FEES AND SERVICES





Audit
      Fees. The
      previous Auditors billed $6,518 in 2002 and were subsequently paid $5,866 by
      the
      Trustee on September 24, 2004. The fee for the audits of December 31, 2002,
      2003
      and 2004 were performed concurrently in 2004 and were $80,000. The fee for
      the
      2005 audit is estimated to be $45,000.





Audit-Related
      Fees. There
      were no audit-related fees for the years ended December 31, 2005 and 2004.





Tax
      Fees. The
      tax-related fees for the years ended December 31, 2004, 2003 and 2002 were
      $15,500. The fee for the 2005 audit is estimated to be $4,000.





All
      Other Fees. There
      were no other fees for the years ended December 31, 2005 and 2004.




-69-
 **Back
            to Table of Contents**
 **Index
            to Financial
            Statements**





**SIGNATURES**








Pursuant
      to the requirements of Sections 13 and 15(d) of the Securities Exchange Act
      of
      1934, as amended, the Registrant has duly caused this report to be signed on
      its
      behalf by the undersigned, thereunto duly authorized.




**SPECTRASCIENCE,
                  INC.**
                **(Registrant)**Date: 
March
                31, 2006
              By:
              /s/ James
                HitchinName:  
                  James Hitchin
                Title:    
                  President, Secretary, Chief Financial Officer
                and Chief Executive
                  Officer
  Pursuant
      to the requirements of the Securities Exchange Act of 1934, as amended, this
      report has been signed below by the following persons on behalf of the
      Registrant and in the capacities and on the dates indicated.


/s/
                James Hitchin
              James
                Hitchin
              (Principal
                Executive Officer and
              Principal
                Financial and Accounting Officer)/s/
                Chester E. Sievert
              Chester
                E. Sievert, Jr.
              Director/s/
                Rand P. Mulford
              Rand
                P. Mulford
              Director/s/
                Mark D. McWilliams
              Mark
                D. McWilliams
              Director






-70-